A study in the concept of balanced development with particular reference to the Nurksian doctrine of balanced growth

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A study in the concept of balanced development with particular reference to the Nurksian doctrine of balanced growth
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Thesis--University of Florida.
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by Yoon-Bock Awh.
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A STUDY IN THE CONCEPT OF BALANCED

DEVELOPMENT WITH PARTICULAR

REFERENCE TO THE NURKSIAN DOCTRINE

OF BALANCED GROWTH









By
YOON-BOCK AWH


A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL OF
THE UNIVERSITY OF FLORIDA
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF DOCTOR OF PHILOSOPHY









UNIVERSITY OF FLORIDA
June, 1960













ACKNOWLEDGMENT


The writer wishes to express his deep gratitude to the members

of his Supervisory Committee: Professors Allen N. Sievers, chairman,

John N. Webb, Clement H. Donovan, C. Arnold Matthews, W. K. McPherson,

and John A. Harrison. They were most generous with time and suggestions.

The writer is especially indebted to Professor Sievers for his time,

effort, and helpful criticisms and suggestions on the content as well

as on matters of syntax and style. The writer was also immeasurably

assisted in the completion of his study by Professor Donovan, Head of

the Department of Economics. But for his understanding and his making

possible financial help through fellowships and assistantships, this

study would not have been completed.

A note of thanks is due to the writer's wife, Pongsoon, for her

constant encouragement and her patience in typing this study in its

final form as well as in its various preceding forms. Appreciation is

also expressed to Mr. iwa Yol Chong for his assistance in typing a

sizable portion of the final manuscript.















TABLE OF CONTFTS


ACKIOWI(EDOGaTS. . . .

Chapter

I. INTRODnCTI .. ............ .. .

II. THE NURKSIAN DOCTRINE OF BALANCED GROWTH .

The Nurksian Doctrine of Balanced Grovths
An Exposition
Nurkse's Position in Historical Perspective

III. CRITIQUE OF THE NIBKSIAN A MI ,T .

The Contribution of the Nurksian Thesis
Critique of Horizontal Balance Criterion
Critique on the Income Elasticity of Demand
as the Measure of Balance

IV. CRITIQUE OF TBE NURKSIAN ASSUMPTIONS .

The Assumption of Private Enterprise
The Assumption Regarding Deaand Conditions
The Income Elastiioty of Demand as the
Investment Criterion: Further Critiques

V. CONSIDERATION OF PROBLKS NEGLECTED IN THE
W*RKSIA ANALYSIS ................ .

Nurkse's Abstraction from Supply Analysis
The lack of External Econamies and Balance
in Supply
Balance among Sectors


iii


Page

ii



1

11














VI. CONSIDIBATIOK OF PROBLEMS NEGLECTED IN TEB
NURKIAN ANALYSIS -- COTINU . 105

The Significance of Capital Supply and
Resource Endowment
The Implication of Capital Supply and
Resource Endowment on Balanced Development
Balanced Development as a Relative Concept:
The Implication of Capital Supply and
Resource Endowment -- Continued

VII. DIFFICULTIES IN FORILATIBG A SATISFACTORY
CONCEPT OF BAIANCED I VELOPMBT . 130

The Need of a Dynamic Concept of Balance
Balanced Development as Macro- and
Micro-Criteria

VIII. BALANCE VERSUS PRIORITY . 113

Balance versus Priority
The Case for the Concept of Balance
Balance and Priority

IX. GENERAL EVALUATION AND CONCLUSION . 158

BIBLIOGRAIEf .................. ....... 167


Chapter


Page














CHAPTER I


INfTODUCTION


This study is a critique of the doctrine known as "balanced

growth" proposed by the late Professor Ragnar Nurkee in his 1953 volume,

Problems of Capital Formation in Underdeveloped Countries.1 It tries

(1) to identify the Nurksian doctrine of balanced growth as to its

content as well as to its origins, (2) to evaluate the doctrine within

Nurkse's own set of presuppositions and his own framework of analysis,

and (3) to re-evaluate the doctrine in terms of the larger framework of

capital formation and economic development of underdeveloped countries

so as to see the full potentialities and limitations of a theory of

balanced development or growth.

The term "balance," "balanced development," or "balanced

growth" has been used quite often in the rapidly expanding literature

on economic development. Not infrequently it is regarded as of critical

importance to development.2 The literature, however, is usually lacking


New York: Oxford University Press, 1953.

2For example, W. A. Lewis writes "the secret of most develop-
ment problems is to maintain a proper balance between sectors.. "
See his Theory of Nconaoic Growth (London: Allen & Irwin, 1955), P. 1l.
A United Nations' study also reads "manufacturing agriculture,
power and transport and export activities .. upon whose balanced
growth integrated economic development depends." Cf. Process and
Problems of Industrialisation in Underdeveloed Countries (lew York:
Department of 2onomics and Social Affars, United Nations, 1955), p. 2.

1











in explicit definitions of the term. If one attempts to find from the

context what definitions are implicit he discovers that a wide range

of different and often conflicting concepts is being covered by the

single word "balance." The concept of balanced growth, thus, is one

of the most elusive in the literature. "The balance or balanced

growth has so many meanings that it is in danger of losing them all."3

Whether balance has any particular meaning or not depends on the

context.

The various meanings attached by economists to balanced

growth range all the way from the most exact one defined by mathe-

matical equations to the most vague one having only rhetorical value.

At one extreme, it represents a mathematical expansion path in which

the economy changes only in scale and not in composition. Thus,

Solow and Saauelson write:

By balanced growth (or decay) we mean a state of affairs in which
the output of each commodity increases (or decreases) by a
constant percentage per unit of time, the mutual proportions in
which commodities are produced remaining constant. The economy
changes only in scale, but not in composition.

Balanced growth has been defined to mean X(t+1l) = Eg(t) for
each and for some positive constant A, where XW(t) is the output
of the ith camodity in period t_7.5

At another extreme, "the word has purely rhetorical meaning,


3Charles P. Kindleberger, Economic Developnt (New Yorks
The McGrawvHiU Book Company, Inc., 1958), p. 149.

4Robert M. Solow and Paul A. Samuelson, "Balanced Growth
under Constant Returns to Scale," Econometrica, July 1953, p. 412.

Ibid.. p. 414.












like 'vell-conceived plans' or carefullyy integrated projects,' and

means little more than 'successful'."6 For example, the title of

the American Economic Association's discussion of the role of monetary

policy in economic development was "The Monetary Role in Balanced

Economic Growth."7 Out of the five participants only Ellis referred

to the word balance and this in an obscure way: "But economic growth,

even balanced economic growth, as an objective of monetary policy is

extraneous and potentially pernicious."

Between these extremes are a number of other meanings.

Moreover, many people veer among various meanings. By the same word

balance one might mean very different things in different contexts.

Let us take a quick glance at some of these different meanings.

For some economists, balance means equilibrium. Thus Vakil

and Braheanand write: "In an economy in which every thing is in

balance, both short-period as well as long-period productive oppor-

tunities too would tend to be in balance."

Occasionally balance refers to the expansion of consumption

so as to aatch the growth of productive capacity "Balanced economic

growth can be defined as a development in which the growth of

6Kindleberger, p. it. 19.

7American Economic Review Papers and Proceedings, May 1956.
8bFid., p. 208.
9C. N. Vakil and P. R. Brahaanand, Planning for an Expanding
Econ om Accumulation ployment and Technical Progress in Under-
developed Countries (Bsobay: Vora & Co., 1956), p. 335.












consumption matches the growth of productive capacity in the consumer-

goods sector.10

By balanced growth is often meant balanced development among

various sectors or regions. For example it might refer to a balance

between the agricultural and industrial sectors: Emphasizing the

importance of balance among sectors, W. A. Lewis writes: "The various

sectors of the economy must grow in the right relationship to each

other, or they cannot grow at all." "In development programmes all

sectors of the economy should grow simultaneously, so as to keep a

proper balance between industry and agriculture, and between production

for home consumption and production for export."1

To some, balanced development is achieved by assigning

priorities "Balanced economic development depends on assigning

priorities to projects according to their contribution to the produc-

tivity of the economy."13 "The road to balance is through priorities

for investments which change people. Balance can be more surely

achieved by concentrating on those places which will let the energy of

the society achieve it for itself."*1

1Eoonomic Survey of Europe in 1955 (GenerTa Economic eam-
nission for Europe, United Nations, 1956), p. 76.
1Op. cit., p. 276.

12Ibid., p. 283. See also Sumitro Djojohadikusuao, "Balanced
Development of Agriculture and Industry," Econamics and Finance in
Indonesia. July 1953; James S. Dusenberry, Discussion American
Economic Review, Papers and Proceedings. pp. 558-66.

13Taxes and Fiscal Policy in Underdeveloped Countries
(New York: Technical Assistance Administration, United Nations, 1954),
P. 5. .
l'Kindleberger, op. cit., p. 166.












In still other meanings, "balance is a motto opposed to

the development through the establishment of manufacturing

industries, and serves primarily as a salutary reminder not to neglect

agriculture."15 Ironically enough the sae term is used by others as

a slogan to oppose concentration on primary production and to advocate

industrialization and diversification.

Finally, balanced growth means a simultaneous expansion of

various consumer-goods industries, or "more or less synchronized

application of capital to a wide range of different consumer-goods

industries.16 This is the meaning ascribed to the term "balance" by

Ragnar Nurkse in his doctrine of balanced growth.

Among the multitude of meanings attached to the concept of

balanced growth, however, Nurkse's formulation of it stands out

singularly. Nurkse's is the most clear-cut and extensive treatment of

the concept of balanced growth, and it is the most widely known among

students of economic development. Thus, when students of economic

development talk about the concept or doctrine of balanced growth they

usually associate it with Nurkse and his formulation of it. Indeed,

Nurkse's formulation is for many economists almost the doctrine of

balanced growth. Thus, to name a few, Marcus Fleming, John Sheahan,

Harvey Leibenstein, and John M. Hunter17 are talking about Nurkse's


15Ibid. 150. urkse, op. ., p. 11.

17Marous Fleming "External Economies and the Doctrine of
Balanced Growth," Economic Journal, June 19551 John Sheahan, Inter-
national Specialization and the Concept of Balanced Growth," Quarterly
Journal of Economics, May 1958j Harvey Leibenstein, Economic Backward-
ness and Economic Growth (New York: John Wiley & Sons, Inc., 1957),











formulation when they refer to "balanced growth." As a matter of fact,

Nurkse's doctrine has repeatedly been discussed by specialists in the

field. For example, when the American Economic Association had a

special discussion on balanced economic growth at its Seventy-first

Annual Meeting in December, 1958, most of the participants referred to

Nurkse and his concept of balanced growth.18 It is because of the

central position occupied by Nurkse's formulation of the doctrine that

the present writer undertakes a critical evaluation of the Nurksian

thesis.

A preliminary precis of the Nurksian formulation might be

useful at this point. A more elaborate summary will be developed in

Chapter II.

In underdeveloped countries there is little incentive to

invest capital in the introduction of modern large-scale production

technique in any single industry producing goods or services for

domestic consumption. The major cause of this trouble is the narrowness

of the market. Reflecting the low level of production and income, the

domestic market for any particular manufactured consumer-good is likely

to be inadequate to absorb the normal output of an efficient modern

plant. The workers in the plant itself cannot compensate for the


p. 107) John M. Hunter, "Icoanoic Growth and Development: Discussion,"
American Ecoomic Review, Papers and Proceedigs, May 1957, p. 61.

1Goran Ohlin, "Balanced Economic Growth in History"j
J. R. T. Hughes, "Foreign Trade and Balanced Growth -- The Historical
Fraevwork"l Rudolph C. Blitz, "Discussion of Papers by J. R. T.
Hughes and Goran Ohlin on Balanced Growth in Zooncmic History," all
in American Economic Review, Papers and Proceedigs, May 1959,
pp. 330-57.












deficiency because they will spend their incomes on a variety of goods

and services and not only on the product of their plant. Therefore,

the plant will be an uneconomic proposition and will not be established.

However, since the expansion of any one industry would increase the

demand for the products of other industries, Nurkse suggests that the

incentive to invest would be much greater if investment in a wide range

of consumer-goods industries were undertaken simultaneously. Then,

people working in a number of different industries would became each

other's customers. The deadlock of the narrow market would thus disap-

pear. In short, while isolated investment in any particular industry

taken by itself is unprofitable, "a more or less synchronized appli-

cation of capital to a wide range of different industries,"19 becomes

profitable.

The above summary of the Nurksian doctrine of balanced

growth suggests that the two distinctive elements of the doctrine

are (1) its emphasis on the role of insufficient demand as a key

factor inhibiting investment and growth in underdeveloped countries,

and (2) its offer of "balanced," "simultaneous," or "all-around"

development in the consumer-goods sector as the solution to overeoam

this difficulty.

This theory of economic development has been subjected to a
20
number of destructive criticisms. They are called "destructive"


19Nurkse, op. cit., p. 11.

S20ee, among others, Marcus Fleming, "External Economies and
the Doctrine of Balanced Growth," op. cit.; John Sheahan, "International
Specialization and the Concept of Balanced Growth," op. cit.












because while many of those critics were quick to point out some real

as well as imaginary shortcomings and to suggest the complete scrapping

of the doctrine, they refused to recognize important contributions of

the doctrine. The effect of these criticisms is to threaten the very

idea of balanced growth itself.

The present study, on the other hand, is undertaken in the

spirit of constructive criticism. The writer attempts to show that

while the doctrine has some grave shortcomings, it also contains some

very valuable insights which will serve as useful guides in the

developmental process of underdeveloped economies.

A brief description of the plan of study concludes this

introduction.

Chapter II is an exposition of the Nurksian formulation of

the doctrine of balanced growth. It attempts to present -- without

introducing the writer's own view -- the Nurksian diagnosis and

prescription of the barriers to capital formation and economic develop-

ment in underdeveloped areas. Only the last section of the chapter is

an exception to the policy of strict adherence to Nurkse's own view,

and examines Nurkse's position in a historical perspective.

The critical evaluation of the Nurksian doctrine is presented

in Chapters III through VIII. Chapter III examines the Nurksian

thesis under Nurkse's own set of assumptions and within his own realm

of analysis. In other words, the chapter confines itself to the analysis

of what has been said by Nurkse without questioning the validity of

the Nurksian assumptions and framework of analysis. The identification












of Nurkse's positive contributions and the critique of the Nurksian

solution of horizontal balance and of his use of the income elasticity

of demand as the measure of balance are contemplated.

Chapter IV, on the other hand, is a critique of the Nurksian

assumption. It questions the validity of the Nurksian assumptions

regarding demand conditions and the private enterprise economy. A

further critique of the use of the income elasticity of demand as the

investment criterion is undertaken.

Chapters V and VI emancipate themselves from the narrow

confine of the Nurksian realm of analysis. Unlike Nurkse who confined

his analysis to the demand side of the problem of capital formation,

the writer undertakes -- in the belief that the study of supply side

is an indispensable component of a theory of balanced growth or

development -- an exploration into the problems on the supply side.

The lack of external economies and social overhead capital

and their implication n economic development of underdeveloped

countries are the central concern of Chapter V. Chapter VI examines

the supply of capital and human and natural resources in underdeveloped

countries, and studies its implication on balanced development.

Chapter VII explores some of the difficulties in developing

the theory of balanced development. The distinction between the

concepts of balance as macro- and micro-criteria is made, and the use

of the concept of balanced development as the macro-oriterion alone is

suggested in view of the difficulty of developing the micro-criterion

of balance.












The question of "balance versus priority" as investment cri-

teria in underdeveloped countries is examined in Chapter VIII. After

some detailed examination of the macro-connotations of the terms

balance and priority, it is shown that the two concepts are not

necessarily competitive but can play mutually complementary roles in

the developmental process of underdeveloped economies.

Chapter IX serves as an over-all summary and evaluation of

the study.















CHAPTER II


THE NURKSIAN DOCTRINE OF BALANCED GROWTH


The NurkAsan Doctrine of Balanced
Growth: An Exposition

Most of this chapter is devoted to a more elaborate restate-

ment of the Nurksian doctrine of balanced growth. Since it represents

a mere exposition of Nurkse's idea itself, 1 the reader is cautioned

not to hold the present writer responsible for the ideas expressed in

this expository section. Needless to say, however, the writer assumes

full responsibility for interpreting Nurkse's meaning, and for

reorganizing Rurkse's materials.


Inducement to invest in
underdeveloped countries

As already noted, the starting point of the Nurksian doctrine

of balanced growth is its emphasis on deficiency of market demand as

the most important single factor impeding private investment in

underdeveloped countries. The deficiency of demand referred to here


1This chapter is based mainly on Chapter I of Nurkse's Problms
of Capital Formation in Underdeveloped Countries, op. cit. Reference
is also made to Nurkse's Some Aspectts of Capital Accumulatio in Under-
develoned Countries (Cairo: The Bank of Egypt, 1952); "Some Inter-
national Aspects of the Problem of Economic Development," American
Economic Review, Papers and Proceedings, May 1952; "The Problem of
International Investment Today in the Light of Nineteenth Century
Experience," The Economic Journal, December 1954; "Trade Fluctuations
and Buffer Policies of Low Income Countries," Kklos, 1958, Fasc. 2.
In the following pages, the first book cited in this note will be
referred to merely as "Nurkse, op. cit."

11












is not in the Keynesian sense of a deficiency of aggregate monetary

demand due to excessive saving, but in the classical sense of a

deficiency of real purchasing power due to prevailing low levels of

income.2 The majority of people in underdeveloped countries today

lack even an adequate provision of such necessities of subsistence

as food, clothing and shelter: they are ill-fed, ill-clothed, and ill-

sheltered. With the most urgent wants still remaining unsatisfied

there is little roan for peripheral postponable wants. People

generally are simply too poor to save; and a deflationary gap through

excessive saving is a sheer impossibility in this poverty-stricken

underprivileged world. The market is narrow and demand is deficient

not because people save too much, but because most people are too

poor to satisfy even their current needs. Under these conditions, the

market could be expanded only if the people's real income were to be

expanded. Here we are in the classical world of Say's law in which

production, by increasing the people's ability to buy, promptly

increases the people's demand for goods and services. J. S. Mill's

following summary of Say's Law, quoted by Nurkse,3 fits the under-

developed world of today fairly well: "Nothing is more true than that

it is produce which constitutes the market for produce, and that

every increase of production, if distributed without miscalculation

among all kinds of produce in the proportion which private interest


2Nurkse, op. cit., pp. 8-9, and 17.

3id., pp. 11-12.












would dictate, creates, or rather constitutes, its own demand."

The extent of the market, in Nurkse's view, is an important

consideration for an entrepreneur in making his investment decision.

Thus, lurkse states that "the inducement to invest is limited by the

size of the market."5 This proposition is, in effect, a modern

variant of Adam aSith's famous thesis that "the division of labour is

limited by the extent of the market." Nurkae gives the credit of

this reinterpretation to Allyn Young. According to Young,7 the

securing of increasing returns depends upon roundabout ways of

production which is the principal economy of division of labour in its

modern forms. The economies of roundabout methods, however, depend

upon the extent of the market. Therefore, taking a country's resource

endowments as given, "the most important single factor in determining

the effectiveness of its industry appears to be the size of the

market."8

aEsays on Some Unsettled Questions of Political economy
(Londona The London School of onomics Reprint, 194), p. 73. For
Say's own descriptions, see his Treatise on Political Econmy, trans-
lated by C. R. Prinsep, New American Edition (Philadelphia Grigg &
Elliot, 1844), Chapter XVj and Letters to Malthus on Political Econom
and Coaerce, Wheeler Economic and Historical Reprints No. 2 (London:
George Harding's Bookshop Ltd., 1936), Letter I: Further consideration
of the applicability of Say's Law in today's underdeveloped countries
will be given in Section 2, Chapter IV.

'Nurkse, op. cit., p. 6.
6An Inquiry into the Nature and Causes of the Wealth of
Nations (Modern Library Edition), p. 17.
7"Increasing Returns and Economic Progress," The Economic
Journal, December 1928, pp. 533 and 539.
8Tid., p. 533.












According to Nurkse, the point that capital investment is

limited by the size of the market has long been familiar to the

practical world of business. In Nurkse's view, it is a matter of

common observation that the use of capital for the production of goods

and services for the domestic market of underdeveloped countries is

inhibited by the lack of domestic purchasing power, i.e., by the lack

of an adequate domestic market. The economic incentive to install

capital equipment for the production of a particular commodity or

service always depends in some measure on the amount of work to be

done with this equipment. If there is a wide market for the particular

commodity or service it will pay for an entrepreneur to install modern

equipment and to take the advantage of round-about methods of pro-

duction. If, on the other hand, there is only a narrow inelastic

market for the commodity or service, reliance on modern production

technique will only mean over-production or underutilization of the

facilities -- an uneconomic proposition which will not be undertaken.

Naturally the individual businessman must take the amount of work to

be done -- the size of the market for his commodity or service -- more

or less as he finds it. He may hope to be able to deflect some of

the present volume of consumer expenditure in his own favor; but where

real income is close to the subsistence level and people are spending

most of their income on the basic necessities of life, there is little

scope for such deflection. The limited size of the market in an

underdeveloped country thus constitutes a real obstacle to the

application of capital by a private entrepreneur producing for that













market.9 "Even though in economically backward areas Say's law may

be valid in the sense that there is no deflationary gap, it is never

valid in the sense that the output of any single industry, newly set

up with capital equipment, can create its own demand."10 This might

be restated by saying that Say's Law is applicable to the economy as a

whole but not to any specific industry taken by itself. Because the

people of the backward areas are poor, additional income accruing to

them is likely to be spent; production, by increasing income, tends to

create demand for various goods and services. There is, however, no

guaranty that the income created by the establishment of any single

industry will necessarily be spent for the purchase of this industry's

product; the creation or expansion of any single industry does not

necessarily create demand for its own product.

Thus, the small domestic market in a low-income country is

an obstacle to capital formation in that country. However, it is

generally agreed that capital formation is a necessary ingredient of

economic development. From this it follows that a narrow domestic

market is an obstacle to economic development generally.

Let us look at the celebrated example of the shoe industry

by which Nurkse illustrates the way in which the small size of a

country's market can discourage, or even prohibit, a profitable appli-

cation of modern capital equipment.


9Nurkse, op. cit., pp. 7-8.

1__bid., p. 9.













Human wants being diverse, the people engaged in the new
industry will not wish to spend all their income on their own
products. Suppose it is a shoe industry. The shoe producers
cannot live on shoes alone and must depend on exchange of shoes
for other things they need. If in the rest of the economy
nothing happens to increase productivity and hence buying power,
the market for the new shoe output is likely to prove deficient*
People outside the new industry will not give up other things iii
order to buy, say, a pair of shoes every year if they do not have
enough food, clothing and shelter. They cannot let go the little
they have of these elementary necessities. If they wre willing
to renounce some of their present consumption in exchange for an
annual pair of new shoes, these things would become available for
the shoe workers to make up the balance in their consumption needs.
As it is, the new industry is likely to be a failure."11

Thus in an underdeveloped country where the great majority

of people are too poor to wear leather shoes, setting up a modern

shoe factory would be a doubtful proposition; the market for shoes

would simply be too small to allow any profitable capital investment.

It is important to note that Nurkse believes that the diffi-

culty of the narrow market is not limited to certain selected types of

industries, but that the difficulty is almost all-pervasive. The

difficulty caused by the small size of the market relates to "iqy

individual entrepreneur in My particular industry."12 Many articles

which would find ready markets in the United States and other economi-

cally advanced countries could be sold to poor people of underdeveloped

countries in quantities so limited that a machine working only a few

days or weeks could produce enough for a whole year's consumption, and

Ibid., p. 9. A reference later on will reveal that Rosen-
stein-Rodan gave a substantially similar argument with the same
example of a shoe factory some ten years' earlier.

12Iurkse, op. cit., p. 7 (italics mine); see also pp. 10-11.












would have to stand idle the rest of the time. According to George

Wythe, for example, a modern rolling mill in Chile -- which is

standard equipment in any industrial country -- can produce rolls for

four-inch angle iron in three hours, enough to last the country for a

year.13 In other cases, foreign branch plants which had been

established in Latin American countries were subsequently withdrawn

because it was found that the local market was too small to make their

operation profitable. These isolated examples may exaggerate the

difficulty, but the difficulty of narrow markets in underdeveloped

countries is real.l Profitable capital investment is deterred by

the limited extent of the market in poor countries. Nurks does not

dispute the technical contribution which capital can bring about in

backward countries, and recognizes that the possible increase in

physical output with modern machinery may be tremendous. But a

businessman is concerned "not simply with physical productivity, but

with value productivity, and this is limited for any individual

business by the poverty of potential consumers."15

In underdeveloped countries which must accumulate capital

to develop their economies, there are only weak incentives to invest

in capital. The most important single cause of this trouble is according

to Nurkse, the inelasticity of demand due to the low purchasing power


lIndustry in Latin America (New York: Columbia University
Press, 1949), 2nd ed., p. 62; or ,urkse, op. oit., p. 7.
lurkse, op. eit., p. 7.

15bid.$ p. 14.












of the people in poorer countries.16 A hungry, shabbily dressed

man's expenditure on foods and clothes are not likely to be deflected

say, to a new pair of shoes. "It is in this way that poverty cramps

the inducement to invest and discourages the application of capital

to any single line of production. The enlargement of the market

through the rise in productivity that would result from increased

capital intensity of production is inhibited by the initial smallness

of the market."17

The trouble is accentuated by discontinuities in the technical

forms of capital equipment and by the short supply of the qualities of

enterprise and initiative in underdeveloped countries.8 Different

industries have different capital requirements, and the optimum scale

varies among different industries. However, to produce with modern

capital equipment means generally, though not invariably, producing

on a larger scale, in the sense of a larger output per plant.

Additions to capital equipment are apt to coa in relatively big units,

and there is especially a characteristic lumpiness in the process of

investment in overhead capital facilities such as railways, power

plants and water works.19 Thus lumpiness of the investment process,

calling for a large discontinuous jump in the rate of output in a small

inelastic market, is likely to aggravate the difficulty of insufficient

inducement to invest.

The lack of innovating entrepreneurs -- who are the central


1bid., pp. 10-11. 17bid., p. 10.
1&bid. 9Ibid.











figures in Schumpeter's theory of economic development -- also keeps

down the inducement to invest in most underdeveloped countries. In

these countries the value systems and social attitudes favorable

to business and industry are usually lacking. A talented youth who

would otherwise have entered the world of business usually prefers

to be a scholar, government official, etc. Thus, "the qualities

of enterprise and initiative are usually in short supply and

the demand for capital tends to be sluggish for this reason alone."20

The availability of entrepreneurship in underdeveloped

countries is limited. Moreover, entrepreneurs' inducement to invest

is kept down by inelastic consumer demand as well as by technical

discontinuities. While technical discontinuities may call for

sizable forward "jumps" in the rate of output, the small and in-

elastic consumer demand in a poverty-stricken country tends to make

such jumps very risky in any branch of industry considered by it-

self.21 If in the past an attempt at investing capital in particular

industries came to grief for these reasons, the individual business-

man is likely to take a pessimistic view of future investment projects;

the demand for capital will be depressed, and the rate of economic

development slowed down.22

The traditional pattern of foreign investment which has

tended to shy away from industries producing for domestic markets in

underdeveloped countries and to concentrate instead on primary


2Ibid.. p. 10. 21Ibid.

16b".












production for export to industrial countries is, according to Nurkse,

evidence which confirms the thesis that "the inducement to invest is

limited by the size of the market."23

From the latest comprehensive figures for American direct
investments it can be seen that of the total invested in
Canada and Western Europe at the end of 1950, 23% was in
extractive industries, as much as 60% in manufacturing and trade,
6% in public utilities and 11% in miscellaneous activities,
including cinemas and other entertainments. Of the investments
outstanding on the same date in all other countries, which with a
few exceptions are economically backward, 60% was in extractive
industries, mostly petroleum and dining, with 20%, 17% and 3%
respectively in the other groups.

Why is it that in underdeveloped areas American businessmen mostly

invest only in extractive industries -- oil fields, mines and plan-

tations -- producing for export markets, while in more advanced areas

they show significant interest in manufacturing industries for local

consumption? According to Nurkse the explanation lies in the extent

of the local markets in the respective areas; that is, in the meager

purchasing power of local consumers in underdeveloped countries on the

one hand, and in the high purchasing power of local consumers in

advanced areas. Private investment -- domestic as well as inter-

national -- is generally governed by "the pull of market demand."2

In underdeveloped countries there is no internal market to assure

profitable investment, only export markets in great industrial centers

23bid., pp. 24-27 and 85-87.

2iurkse, "The Problem of International Investment Today in the
Light of Nineteenth Century Experience," op. eit., p. 753. For
original data, see Survey of Current Business, December 1952, pp. 7-11
and 19.
25Nurkse, op. cit., p. 26.











provide any strong incentive to invest. Foreign direct investment

accordingly has tended to concentrate on primary production which found

markets in advanced industrial nations.26 There never was much induce-

ment for foreign business enterprise to invest in manufacturing indus-

tries; markets there were too small to provide enough incentive.27 The

so-called "colonial" type of foreign investment was created by the

investing countries' own demands for raw materials for their indus-

tries. Such foreign investment was foreign only in a geographic

sense; it formed essentially a part of the investing country's econo-
28
my.

Nurkse repeatedly stressed that the most decisive determinant

of the inducement to invest is the size of the market. But just what

constitutes a market? Here, Nurkse fully accepts the answer given by

Allyn Young. According to Young, what makes up a market is "not area

or population alone, but buying power, the capacity to absorb a large

annual output of goods. This trite observation, however, at once

suggests another equally trite one, namely, that capacity to buy de-

pends upon capacity to produce. In an inclusive view the size

of the market is determined and defined by the volume of production."9

In underdeveloped countries the market is narrow and demand is


26 d., p. 27. 27b., p. 26.

28. W. Singer, "The Distribution of Gains Between Investing
and Borrowing Countries," Aerican r onomic Review, Papers Mnd
Proceedings. May 1950, p. 475.

Young, op. cit., p. 533.











insufficient in the classical sense of the shortage of supply to offer

in exchange. The crucial determinant of the volume of production,

according to Nurkse and Young, is productivity. Thus the most im-

portant single determinant of the size of the market is productivity.30

Capacity to produce means capacity to buy.

The sixe of the market is determined by productivity.

According to Nurkse, productivity, in turn, is largely determined by

the capital intensity of production. Though many things enter into the

determination of productivity of a nation, the degree to which capital

is employed in production is the most Iaportant factor to be singled

out. Productivity, or output per man hour, depends largely on the

use of machinery and other equipment. "It is a function of the

capital-intensity of production."31 To increase productivity in order

to enlarge the market and to promote economic progress,aore capital

must be employed in the process of production. However, for any one

individual businessman the use of capital is inhibited to start with

because of the narrow domestic market in poorer countries.

Thus, we have "a circular constellation of forces tending to

act and react upon one another in such a way as to keep a poor country

in a state of poverty."32 The inducement to invest may be low because


30Nurkse, o. cit., p. 9: There seem to be many others who
realized this interrelationship between productivity and market. For
one, George Wythe in his book the first edition of which appeared in
1945 writes that "the national market can be permanently enlarged only
through an all-round increase in productivity." (O.p cit.. p. 62).

3Uurkse, og. cit., p. 9.

32 ,s., p. 4.












of the small market, which is due to the small buying power of the

poor people in backward areas, which again is due to low productivity.

The low level of productivity, however, is a result of the small

amount of capital used in production, which in its turn is caused by

the small inducement to invest. Where is the way out of this under-

developaent equilibrium trap?


Balanced growth the answer to
insufficient inducement to invest

Nurkse's foregoing diagnosis of the difficulty facing economic

development of underdeveloped societies seems gloomy and dismal enough.

If his analysis stopped there, economics would surely seem to deserve

the old notorious brand of "dismal science." However, to our relief,

Nurkse's gloomy diagnosis is followed by an optimistic prescription.

The circular constellation of underdevelopment equilibri-

um -- however real it is -- is only part of the story. The under-

development trap need not be an inexorable decree of fate. "The

circle is not unbreakable. And once it is broken at any point, the

very fact that the relation was circular tends to make for a cumu-

lative advance. We should perhaps hesitate to call the circle

vicious; it can beae beneficent."33 A theory of stagnation, if it

is to be meaningful, must be succeeded by a theory of development

explaining the forces that are required to lift a backward economy

out of the underdevelopment equilibrium in which it would otherwise

tend to settle.


Ibid. p. 1. Ibid.












Nurkse offers an ambitious solution to overcome the problem

of market deficiency harassing the late-eoaers in the field of

economic development. According to him, what is required to find a

solution is to look at industrial operations as an interrelated

whole. The rate at which any one industry grows is conditioned by the

rate at which other industries grow. Any substantial application of

capital by an individual entrepreneur in any particular industry may

prove to be unprofitable due to the limitation of consumer demand.

But what is true of any single line of production taken by itself is

net necessarily true of a wide range of different industries. A

simultaneous or balanced development of a large number of different

industries brings out an entirely different result from that of

developing a single industry. If a program of balanced development

of many different industries is undertaken, people working in

different projects will becoae each other's customers and the market

difficulty will largely disappear. Balanced growth, therefore, is

our solution. In Nurkse's own words:

The difficulty caused by the small size of the market relates
to individual investment incentives in any single line of
production taken by itself. At least in principle, the difficulty
vanishes in the ease of a m o r less synchronized alication
of capital to a wide range of different industries. Here is an
escape from the deadlookj here the result is an over-all enlarge-
aent of the market. People working with more and better tools
in a number of complementary projects became each other's
eustamers. Most industries catering for mass consumption are
complementary in the sense that they provide a market for, and
thus support each other. This basic caplemeatarity stems, in
the last analysis, from the diversity of human wants. T ease for
balancedd growth' rests on the need for a balanced diet.


35%urkse, op. cit., p. 11 (italics mine).











The important point is to realize how simultaneous over-all

investment in a number of different industries can economically

succeed while any single investment by an individual businessman in

any industry alone may be blocked or discouraged by the lack of

demand. here any single enterprise may appear risky and dubious

because of a narrow market, investing in a whole range of different

industries may succeed because each vill support the other, "People

engaged in each project, now working with more real capital per head

and with greater efficiency in terms of output per man hour, will

provide an enlarged market for the products of the new enterprises

in the other industries."6 Thus, the market difficulty and the

drag it imposes on capital formation and economic development could

be removed by an all-round expansion of market brought about by a

wave of capital investment in a number of different industries.

The notion of external economies, though not quite in the

familiar Marshallian sense, might be applicable to this mutually
37
supporting role of different industries. Each of a wide range of

projects, by contributing to an enlargement of consumer demand, can

be said to create economies external to the individual firm and/or

industry. Rosenstein-Bodan, in a 1943 article, also called the benefit

arising out of simultaneous development of various industries "external

economies." According to him, the development of a complementary

system of industries reduces the risk of not being able to sell.

Since risk can be considered as cost, it reduces cost and creates


36 p. 13.
'Ibid, p. 13.


37 IL.#p 4














economies external to a firm or industry.38 Nurkse, as did Allyn

Young and Rosenstein-Rodan, seems to believe that one of the most

important forms of external economies which leads to increasing

returns is the one which increases the size of the market.3

It must be noted that when Nurkae says that people working

in "a wide range of different industries .. become each other's

customers," the industries to which he is referring are consumer-

goods industries. This follows not only from the logic of his thesis,

but also is clear from his direct reference to "industries catering

for mass consumption."41 Rosenstein-Rodan also made an explicit

statement as to the type of industries he is talking about by saying

that "the industries producing the bulk of the wage goods can be said

to be compleentary." 2

A balanced growth of various industries has been offered as

the answer to overcome market difficulty. But what does Nurkse

precisely mean by the word, "balance"? Though Nurkse gives no ex-

plicit and exact statement of what he means by balance or balanced

growth, it is not difficult to find the implicit meaning attached to

it from Nurkse's scattered references to it. In connection with


38Rosenstein-Rodan, "Problems of Industrialization of Eastern
and South-Eastern Europe," The Economic Journal, Junw-September 1943,
pp. 205 and 207.

N3urkse, op. cit., p. l; Young, op. it., p. 533.

Okurkse, op. cit., p. 11. ~1bid.

2Rosenstein-Rodan, op. cit., p. 205.











discussions of the rate of growth of various industries Nurkse

refers to "patterns of consumer preferences,"3 "pattern of

consumer's demand," and "demand elastieities." 5 From these

references we might, without too much risk of misinterpretation,

infer that Nurkse means by balanced growth the synchronized expansion

of various factory-produced consumer-goods industries at the rates

dictated by the community's income elasticities of demand. The income

elasticity of demand is defined as the ratio between the relative

change in quantity demanded and the relative change in income.

Much the same meaning of balance has also been implied by Young and
".7
Lewis. Nurkse did not elaborate on the problems or procedures

involved in the practical attempt to employ the income elasticities of

demand as the measure of balanced growth.

On the possibility of measuring the elasticities of demand

3"An increase in the production of shoes alone does not
create its own demand. An increase in production over a wide range of
consumables, so proportioned as to correspond with the patterns of
consumer's preferences, does create its own demand." (Op. cit.,
p. 12; italics mine.)

provided of course that the composition of the
increased consumable output corresponds by and large, to the pattern
of consumer's demands." (Ibid., p. 13.)

45"Although naturally some industries grow faster than others
since demand elasticities will vary for different products."
(Ibid.p. pli italics mine.)

46Te difficulties involved in the use of the income elastici-
ty of demand as the measure of balance are examined in Section 3,
Chapter III and Section 3, Chapter IV.

47Young, op. cit. p. 534; W. Arthur Lewis,he Theory of
Economic Growth, op. cit., p. 278.












of various products in underdeveloped countries, Nurkse makes no

statement. But Rosenstein-Rodan is optimistic:

While in the highly developed and rich countries with their
more variegated needs it is difficult to assess the prospective
demand of the population, it is not as difficult to foresee on
what the formerly unemployed workers would spend .their wages in
regions where a low standard of living obtains.

Now that the Nurksian diagnosis of, as well as the Nurksian

prescription for, the trouble of insufficient inducement to invest in

underdeveloped countries have been seen, a summary, in a few words,

of what is want by Nurkse's "doctrine of balanced growth" will be

appropriate. In a nutshell, the Nurksian doctrine of balanced growth

(1) emphasizes the narrowness of the market in underdeveloped

countries as a factor deterring capital formation; (2) recognizes

explicitly the interrelationship between productivity and the size

of the market; and (3) proposes a more or less simultaneous growth of

various consumer-goods industries as the solution to overcome the

difficulty caused by the narrow market.

The foregoing exposition constitutes the main body of Nurkse's

theoretical structure. The following two sections are of secondary

importance to his basic thesis, and deal with the impact of balanced

growth on international trade and the problem of planning versus

private enterprise in executing balanced growth, respectively. The

former topic is restated here (1) because Nurkse's position is often

misunderstood by the critics and (2) because it gives an important


Op. cit., p. 206.











secondary support to the doctrine. The latter is recapitulated here

merely to clarify the position of the doctrine with respect to the

problem.


balanced nrowath and international trade

Repeated attacks on the doctrine of balanced growth have been

made on the ground that it runs against the principle of international

specialization and reduces the volume of international trade. Does it

not mean turning away from the principle of comparative advantage to

undertake a balanced growth or diversification of the domestic

economies of underdeveloped countries? Why do these countries not

push their production and export of primary commodities, and import

the industrial products they need for a "balanced diet"? Balancing

of domestic economies of underdeveloped countries means foregoing the

advantage of specialization and trade. The term "balance," though

helpful as a means of coordinating investment internationally, can be

absolutely unhelpful applied to any one nation taken alone.49

If the critics of Nurkse's doctrine believe that his bold

thesis of balanced growth is based on Nurkse's ignorance of the

opportunity open to underdeveloped countries in the field of inter-

national trade, nothing could be further from the truth. Nurkse was

primarily a student of international trade, and his proposal of

balanced development of industries mainly producing for the domestic

market of an underdeveloped country is founded on a clear understanding


49John Seahan, cit., p. 197.












of the conditions of the international market today. If a rapidly

expanding world market is facing the producers of primary commodities

in underdeveloped countries, concentrated development effort on

primary production would increase the real income of underdeveloped

countries, and might help their economic development. An individual

entrepreneur would then find profitable opportunities to invest his

capital in extractive industries working for export to industrialized

countries. Rich international markets would supplement the narrow

domestic market, and the problem of insufficient inducement to invest

might disappear altogether. Thus, if the existence of a vigorously

expanding market for primary products could be assumed, the principle

of comparative advantage might furnish a valuable guide to the

direction of development in underdeveloped countries. Underdeveloped

countries' concentration on extractive industries for the sake of

export would benefit not only the industrialized countries but also the

low income countries themselves.

According to Nurkse, however, for fairly obvious reasons

"expansion of primary production for export is apt to encounter adverse

price conditions on the world market."50 The nineteenth century type

of steadily expanding demand for raw materials by the industrial

powers does not exist in the present century. There has been srme

sluggishness in the industrial countries' demand for raw materials,

and there is no certainty that this sluggishness is gone for good.51


5hurkse, op. cit., p. 21 (italics aine).


51Ibid.












To push exports of primary commodities in the face of an
inelastic and more or less stationary demand would not be a
promising line of long-run development. If it is plausible to
assume a generally less than unitary price elasticity of demand
for crude foodstuffs and materials, it seems reasonable also to
conclude that, under the conditions indicated, economic growth in
underdeveloped countries must largely take the foray of increased
production for domestic markets. Under these conditions,
if there is to be any development at all, it must concentrate at
least initially on production for local requirements.52

Thus, today's world market conditions might make it imperative

for underdeveloped countries not to concentrate on primary commodities

but to work for their domestic markets. Nurkse, however, does not

stop with this rather negative defense of balanced growth. Be has a

convincing positive defense, too. In his opinion, balanced

growth -- as a means of enlarging the market, stimulating capital

investment, and increasing productivity and real purchasing power --

is an indispensable basis for expanding international trade. It is

well-known that, because of their low level of productivity and hence

of real purchasing power, underdeveloped primary-producing countries

play only a minor role in international trade; by and large, the

advanced industrial countries with their high productivity and

purchasing power are each other's best customers.53 Indeed, "balanced

growth, as a means of enlarging the market and stimulating the

incentives for higher productivity through capital investment, is an

essential basis for expanding trade."54 Thus, in Nurkse's model,


52Id., p. 22. 53bi., pp. 20-21.

"Ibi., p. 21.











balanced growth will in the long run tend to help rather than hinder

the growth of world trade.


Balanced growth and the question of
lannind versus private enterprise

The Murksian doctrine of balanced growth is fundamentally a

thesis related to a private enterprise economy. The difficulty of the

narrow domestic market reduces entrepreneurs' inducement to invest.

The solution of balanced growth is a measure to relieve the difficulty

faced by private entrepreneurs. There can, however, still arise the

question, Is balanced growth to be left completely to the action of

private entrepreneurs or is it to be deliberately organized by some

sort of central planning? Nurkse offers no categorical answer to

this question. Re thinks that whether balanced growth is enforced

by coordinated central planning or achieved spontaneously by innova-

ting entrepreneurs is a question of method, and that his main concern

is the economic nature of the solution and not the administrative form

of it. He takes a neo-classical economist's stand on value judgment

and declares "the economist, as an economist, has no categorical

imperatives to issue on this subject55 of planning versus private

enterprise,

Though Murkse emphasizes the important role played by the

profit motive of private entrepreneurs, he goes on -- probably as a

social philosopher if not as a careless economist -- to adumbrate


55Ib., p. 16.












the need of coordinated central planning for balanced growth in most

underdeveloped countries today. The question of method must be

decided on the ground of, among other broader considerations, "human

qualities and motive forces existing in any particular society." The

main source of the human qualities of enterprise and initiative in the

industrial development of Western Europe was, according to Nurkse, the

middle class. That middle class, however, is virtually non-existent

in many backward countries today. Schumpeter' s "swar-like appearance

of new enterprises" -- which seems to have what it takes for balanced

growth -- an not be relied on to lead the process of balanced

economic development in today's underdeveloped world. Private enter-

prises are still too weak, and the socio-political atmosphere may

not be conducive to a rapid development of them.

It may be that the forces that are to defeat the grip
of economic stagnation have to be deliberately organized to same
extent, at any rate initially. In the early industrial develop-
ment of Japan, for instance, the state was the great innovator
and the industrial pioneer on a vide front.7

The emphasis given to the role of public finance in the

concluding chapter of his book, as vell as the frequency with which he

refers, in various contexts, to the role of government in the economic

growth of underdeveloped countries58 also reveals the importance

attached by Nurkse to the leading role of government.



56id., p. 16. 57i., p. 15.

or example, ibid., pp. 96, 110, 140, 13, 1, 151, 152,
etc.












Rurkse's Positio in Ristorical Perpsective

The concept of balanced growth as advanced by Iurkse, like

many important ideas in social sciences, is not an entirely novel

creation of a single individual. Not only Nurkse but also many

other people are associated with the development of the concept.

As it was adumbrated in the preceding expository section,

Nurkse's thesis has things common to Adam Smith, J. B. Say, and Joseph

A. Schumpeter. In Smith we find the emphasis of the extent of market

as the limiting factor of the division of labor, which is the main

determinant of productivity. In Say, we find emphasis on production

as the ultimate source of purchasing power. And in Schumpeter we

find the emphasis on over-all development, i.e. the broad waves of

innovating entrepreneurs. All these concepts doubtlessly play cer-

tain roles in Nurkse's thesis. It is, however, in Allyn Young and

P. N. Rosenstein-Rodan that we find the mediate forerunners.

Smith's thesis that "division of labour is limited by the sise of

the market"9 had to await Allyn Young's reinterpretation before

it could readily form a part of Nurkse's thesis. The main emphasis

of Say's Law was not to stress but to minimise the Importance of

market demand. Schumpeter's innovating entrepreneurs axe conspicuous

by their absence in underdeveloped areas. Young and Rosenstein-

Rodan, on the other hand, gave the same kind of stress and a similar

solution as was given in Nurkse's doctrine.

59
OPn cit. p. 17.












Allyn Young in his 1928 article "Increasing Returns and

Economic Progress" stressed the importance of market demand for

industrial growth and the interrelationship of various industries.

The securing of increasing returns depends upon the progressive

division of labour, whose principal economies in its modern forms

are derived from using labour in roundabout ways. The economies of

roundabout methods, however, depend upon the extent of the market.6

Therefore, "taking a country's econaoic endowment as given, the

most important single factor in determining the effectiveness of its

industry appears to be the size of the market."62 Young not only

emphasizes the importance of market but also points out productivity

as the determinant of the size of market. Capacity to buy depends

upon capacity to produce. The size of market is "determined and

defined by the volume of production." 6 The reader will remember that

this is almost identical with the explanation given by Nurkse.

Interrelationship of industries is clearly discerned by Young.

The rate at which any one industry grows is conditioned by the rate

at which other industries grow. Progressive division and speciali-

zation of industries is an essential part of the process by which in-

creasing returns are realized. Therefore, to understand the mechanism

of increasing returns, industrial operations must be seen as an


q. oit., pp. 527-42. bd., pp. 531 and 539.
62mThid., 533. 63Ibid.

6_.bid.1, p. 534.












integrated whole.65 Furthermore, the enlarging of the output of

any one comodity produced under increasing returns generally has

the net effect of enlarging the market for other ceomodities. If

the composition of output is balanced, "an increase in the supply of

one comodity is an increase in the demand for other coodities." 6

By emphasizing the role of the market in industrial growth

and by shoving the interrelationship of industries not only as

complementary suppliers and buyers at different stages of production

(balance in supply) but also as each other's eustoers through inocae-

creating effects (balance in demand), Young has laid important

foundations for the development of the doctrine of balanced growth.

Indeed, once one recognizes the importance of the market in economic

development and the possibility that increased production of one

commodity results in an increased market for other goods in general,

then one does not have to jump too far to reach the thesis that the

solution to overcome the narrowness of market lies in a simultaneous

development of various industries. Young, however, might be called

an anticipator of the concept of balanced growth rather than a pro-

ponent of it, for he did not suggest any balanced or simultaneous

growth approach as the means to widen the market.

The doctrine of balanced growth in the Nurksian sense is

clearly spelled out by P. N. Rosenstein-Rodan in the above-mentioned


65id., p. 539. 66I ., p 537.

67Ibid., p. 534.













1943 article "Problems of Industrialization of Eastern and South-
f68
Eastern Europe." Though Rosenstein-Rodan does not elaborate the

difficulties caused by the narrow market, he clearly recognizes the

role of the market. To overcome the barrier of the narrow market,

he proposed the solution of simultaneous or balanced growth approach,

i.e., "a scheme of planned industrialization comprising a simultaneous

planning of several complementary industries."69 In arguing for such

a simultaneous development, Rosenstein-Rodan emphasizes complementarity

of different industries. He points out that if we put say, 20,000

unemployed workers into a large shoe factory, the project will be a

failure because there will not be sufficient demand to make it

profitable. If, instead, one million workers were put not into one

industry, but into a whole series of consumer-goods industries on

which workers would spend their wages, what was not true in the case

of one shoe factory would become true in the case of a whole system

of industries. The development of a whole series of industries would

create its own additional market. Industries producing the bulk of

consumer-goods can therefore be said to be complementary. By reducing

each other's risk of not being able to sell, they provide a "a special

case of external economies."70

Complementarity of different industries, according to


68p. cit., pp. 202-11.

69Ibid., p. 204: Rosenstein-Rodan, however, did not use the
term "balanced growth."

70Ibid., pp. 205-206.












Rosenstein-Rodan, arises not only from the demand side but also from

the supply side. Several other types of "external economies" will

arise when a system of different industries is created. First, there

are the strictly Marshallian economies external to a firm within a

growing industry. Secondly, there are economies external to one

industry due to the growth of other industries. Thirdly, training of
71
labour, which is the first task of industrialization, could very

profitably be undertaken if a whole series of industries is treated

and planned like "one huge firm or trust." There are no mortgages

on workers -- an entrepreneur who invests in training workers may lose

money if these workers contract with other firms. But there is no

such risk in the case of a series of industries to be created when

taken as a whole. Though it is usually assumed that these external

economies are not very considerable, they might be very Important in

magnitude in the case of fundamental structural changes in under-

developed countries.73 If we create a sufficiently large investment

unit by including all the new industries of the region those important

external economies will be internalized: "external economies will
74
become internal profits out of which dividends may be paid easily."74

By recognizing the place of the market in industrialization


Though Rosenstein-Rodan singles this out for emhasis, this
is nothing more than an example of external economies of the first
and/or second type.
72
Rosenstein-Rodan, op. cit., pp. 204-205.

73bid., p. 206. 74bid., p. 207.













and by proposing a series of industries treated like one huge firm as

the solution to overcome the difficulty of narrow market, Rosenstein-

Rodan has drawn an almost perfect blue-print for the doctrine of

balanced growth in Nurkse's sense. The persuasive example of the shoe

industry is also found in Nurkse's exposition without any substantial

change. It is important to note that Rosenstein-Rodan, in arguing for

simultaneous development of various consumer goods industries, mentions

complementarity in supply (as distinguished from compleaentarity in

demand) among different industries. This consideration of comple-

mentarity in supply completely drops out of the picture in Nurkse's

formulation, which concentrates on the demand side.

From the foregoing exposition, it is clear that the Nurksian

formulation of the doctrine of balanced growth is, in historical

perspective, a synthesis and elaboration of the ideas put forward

mainly by Allyn Young and P. N. Rosenstein-Rodan. Nurkse, however,

made a great step forward to the concept of balanced growth by pre-

senting the most clear-cut and extensive treatment of it, and thereby

attracting attention of economists to the subject. Because of this,

despite so many meanings attached to the term "balance" by economists

(as the introductory chapter shows), when students of economic develop-

ment talk about balanced growth they usually associate it with Nurkse

and treat his formulation as if it is the doctrine of balanced growth.















CHAPTER III


CRITIQUE OF THE NURKSIAN ARGUMENT


The preceding chapter was an exposition of the Nurksian

doctrine of balanced growth. It is now time to undertake a critical

analysis of the doctrine. For the sake of clarity this study divides

its critique of the Nurksian doctrine into two parts. In this chapter,

all of the Nurksian presuppositions as well as its analytical frame-

work are fully accepted. Nurkse's thesis is, thus, subjected to a

critical examination in terms of its own assumptions and within its

own scope of analysis only. The following chapters will reevaluate

the Nurksian doctrine in the light of the total framework of capital

formation in underdeveloped countries. There not only the Nurksian

presuppositions are questioned, but also the Nurksian framework of

analysis is reexamined with reference to the total galaxy of causal

forces in the process of capital formation.

Nurkse is concerned with the inducement to invest of private

entrepreneurs in underdeveloped countries. Furthermore, Nurkse's

analysis "concentrates on the demand for capital, as exercised by

individual entrepreneurs, and abstracts from any supply difficulty."1

In short, the Nurksian framework of analysis assumes a private


Nurkse, "Balanced Growth on Static Assumptions," The EcQnmic
Journal, June 1956, p. 367.












enterprise economy and abstracts from the supply side of the problems

of capital formation.

In the Nurksian analysis, the narrowness of the domestic

market is an important barrier to capital formation in underdeveloped

countries. The much desired private investment for the establishment

of modern industrial facilities is discouraged because the output of

potential investment projects is likely to encounter an "inevitable

inelasticity of demand."2 Some of the remedies which will readily

occur to the minds of economists to deal with the difficulty of the

narrow market are likely to be increasing market research and cost-

reducing innovations. Provision of better communication and transpor-

tation networks and of government assistance to some industries whose

development are hindered by the narrowness of the domestic market

might also belong to this category.

Nurkse, however, goes deeper to attack the root of the

difficulty of the domestic market, namely, poverty itself. The do-

mestic market is narrow because people are poor and lack adequate

purchasing power. Then, what is needed is to create the purchasing

power at the same time the supply of industrial goods is increased.

Nurkse, accordingly, asserted that a more or less simultaneous develop-

ment of various consumer-goods industries will eliminate the difficulty

caused by the narrow market. People working in a number of different

projects will become each other's customers, and the difficulty of

insufficient domestic demand will largely disappear.


2Problems of Capital Formation, op. cit., pp. 9-11.













Since the Nurksian presupposition of private enterprise and

that of the importance attached to the demand condition are not

questioned here -- nor is the Nurksian framework which confines itself

to the demand side alone -- the critique in this chapter centers

around the case for balanced growth, i.e., a more or less synchronized

development of various factory-produced consumer-goods industries at

the rates dictated by the community's income elasticities of demand.


The Contribution of the Nurksian Thesis

In recent years, most discussions of the problem of capital

formation and economic development of underdeveloped countries have

usually centered around the question of the supply side of capital

formation. It is in this particular context that the Nurksian

contribution must be evaluated. By stressing the difficulty involved

on the demand side of the problem of capital formation, and by offering

a solution to overcome the difficulty of demand deficiency, Nurkse

brought the attention of the economic profession back to the aspect

of the problems of capital formation which has been rather neglected

in recent years. Such a redirection of the attention of students of

economic development back to a neglected aspect must be a significant

contribution towards a better understanding of the problem of capital

formation and economic development.

Nurkse's proposed remedy of "balanced growth" rests upon a

clear recognition of (1) the complementary interrelationship among

various industries, and (2) the interrelationship between the size of

the domestic market and the productivity of a nation. Though these











insights are not, as it was seen in the preceding chapter, Nurkse's

own entirely novel contributions, his explicit statement of the

matters has redirected the attention of economists back to the im-

portant economic interrelationships. Students of economic development

certainly owe a debt to Nurkse for reminding them of these important

aspects of the problem of capital formation.

Probably one of the most significant contributions of the

Nurksian proposal of the more or less simultaneous development of a

multitude of industries is to suggest the scale of the problems

involved in the economic development of underdeveloped countries.

While the emphasis on a priority approach is likely to suggest that

the task of economic development can be achieved by a selection of a

few best branches of an economy and concentrating on them, the

Nurksian doctrine of balanced growth -- by asserting the necessity

of synchronized development of various consumer-goods industries --

underscores the huge scale of the problem involved in the economic

development of underdeveloped countries.

If an underdeveloped country is to develop successfully, it

might be necessary for that country to make a great concentrated effort

to increase its output. The choice might indeed turn out to be not

between large and small progress but between large progress and no

progress at all. Small piecemeal attempts might bring forth no perma-

nent improvement at all, and the economy might revert to its under-

development status. The possibility of increasing total output of a

society by piecemeal development projects are, of course, not denied.

But achieving economic development involves a task far greater than











mare increase of total output.

What is important for the betterment of economic life of the

population is per capital output and income rather than the total

income and output. If the rate of increase of population -- which is

generally very high in underdeveloped societies -- outstrips the rate

of increase of output, a country's per capital income will decrease

and so will the well-being of its populace. While the reduction of

death rates is welcome in almost any culture, and can be achieved

without great difficulty by the introduction of modern medicine, the

reduction of birth rates is not readily accepted in many cultures.

Moreover, inexpensive, simple, effective measures to control fertility

are hard to find. The reduction of the rate of population growth,

therefore, is not easy, especially at the early stage of the economic
3
development of a nation.

Thus for successful development, a momentum for the increase

of output faster than the rate of population growth must be created.

This is not an easy task to be solved by lukewarm marginal economic

changes. It may require a total structural change of a socio-

economic-political nature. And for successful development, such over-

all efforts on various fronts might have to come relatively early in

the development attempt, A successful development requires, to


3This must not be misinterpreted as slighting the
importance of the measures to reduce the rate of increase of
population.












mention only some of the important factors, such social, political,

and economic improvements as: the creation of an environment conducive

to economic pursuit and lower birth rate; preservation of stable legal

system and government which safeguard economic activity; establishment

of tax and credit systems which are conducive to productive capital

formation; provision of social overhead capitals such as transportation

facilities and power supplies; and securing of adequate markets. All

these factors reinforce each other to promote economic development.

The process of economic development is really a dynamic process which

requires change and development of all sorts. Probably one of the

most important lessons underdeveloped countries aspiring for economic

development should learn is to realize the magnitude of the problems

involved in achieving economic development and to realize that develop-

ment is not likely to be achieved without a determined large-scale effort

on many fronts. Nurkse's thesis of balanced growth, although narrow in

focus, seems to offer the very lesson of the need for an all-out

effort by dramatizing the magnitude of investment required.


Crititue of Horiontal Balance Criterion

Nurkse's concept of balanced growth -- horizontal balance of

different consumer-goods industries -- was a very natural outcome of

the strong emphasis given by Nurkse to the demand side of the process

of capital formation. According to Nurkse, the most important single

cause of the deficiency of demand is the poverty of the local popu-

lation. LMst of the income of these poor people is spent for the basic













necessities of life since they live at the margin of subsistence.

Most agricultural and fishery products are among the necessities of

life, and therefore, will not suffer too much from the narrowness of

the market. Industrial products, however, reflect in general a higher

level of living, and therefore are hard-hit by the lack of domestic

demand. Thus, Nurkse's consideration of the demand problem of capital

formation led him to emphasize industry at the neglect of other

sectors and to offer as the solution a more or less synchronized

development of various consumer-goods industries.

Nurkse's concept of horizontal balance, however, need not be

confined narrowly to consumer-goods industries alone. What Nurkse was

interested in was to increase productivity and income of the people

so that there would be sufficient demand when industrial investment

occurs. Not only balanced development of consumer-goods industries

but also any developmental approach which increases productivity and

income will serve to widen the domestic market. For example, the

market for a newly developing shoe industry will be just as much

widened by a concomitant development of the agricultural sector as

by a more or less simultaneous development of various other consumer-

goods industries.

In fact, Nurkse's proposal of a more or less simultaneous

development of consumer-goods industries is not sufficient to overcome

the difficulty of the narrow domestic market. The workers of various

consumer-goods industries do not live by manufactured consumer-goods

alone. Industrial workers in poor countries -- whose wage level













cannot be very high -- will spend a very important part of their

income for the purchase of such primary products as foods and fuels.

Thus it is obvious that increased income resulting from capital

investment in consumer-goods industries will, to an important extent,

leak out into non-industrial sectors. The inevitability of this

leakage to other sectors means that a synchronized development of

consumer-goods industries alone will not be sufficient to assure an

adequate market for consumer-goods industries.

One might object to the immediately preceding statement asking

"would not the leakage be offset simply by increasing the number of

consumer-goods industries to be created?" It can, however, be easily

shown that this objection cannot be sustained. Some numerical example

might clarify the problem. Assume that 10 industries (A, B, J)

are created, each producing $1 million worth of commodities, or a

total of $10 million. Also assume that 50 per cent of the income, or

$5 million created in the industries will leak out into the primary

sector, and the remaining 50 per cent will be equally spent among

products of 10 industries. Each industry's share of the market will

be 10 per cent of the income left for the purchase of industrial

goods, or a half million dollars, which is only half of the value of

their products. If 10 more industries are created, and if we can


1Incidentally, this is not an unrealistic figure in the case
of the Korean experience. In 1956, the citizens of Seoul spent, on
the average, some 51 per cent of their income on foods, fuels, and
lights. See Annual Economic Review, 1957 (Seoult The Bank of Korea,
1957), Part IV, p. 266.











assume that 10 per cent of income left over for the purchase of

industrial sector will still be spent say, for, industry A's product,

then demand for industry A will increase by half a million dollars,

and will thus justify the operation of industry A. But industry A's

problem is solved only at the price of aggravating other industries'

demand difficulties. By securing the sale of $1 million for its

product, industry A leaves less to be divided among the remaining

19 industries. The latter's average share is now even smaller than

a half million dollars.

A more plausible assumption would be that when the number of

industries is increased by 10 making the total 20, the share of each

industry will become one-twentieth instead of one-tenth of the total

income spent for industrial goods. Thus, mere increase in the number

of consumer-goods industries alone -- though it might solve the market

problem of some industries at the expense of others -- cannot offset

the leakage of income out of the industrial sector. As long as man

does not live by industrial goods alone, there will be a leakage.

Under a more unlikely set of assumptions, there does

exist a situation in which a more or less simultaneous development of

consumer-goods industries might create a sufficient market of its own.

Assume an entirely agricultural country with a considerable amount of

hidden unemployment. Under these conditions, some of the agricultural

labour force could be transferred to a newly developing consumer-goods

industries without reducing the agricultural output. Assume further

that industrial workers will continue to consume the same amount of











agricultural products as they did before in the rural area, and that

the remaining agricultural population will not increase their con-

sumption of agricultural products after some of their members leave

home to Join the industrial forces in town. The possibility of saving

might also be assumed way in harmony with the Nurkstan emphasis on

the deficiency of demand.

A certain percentage of the farm population is now transferred

to the city to create a group of consumer-goods industries. As before,

assume that $10 million of consumer-goods are produced by 10 newly

established conaumer-goods industries. Also assume that -- as it was

done before -- the industrial workers will spend 50 per cent of their

income on primary products, and the rest on products of the 10 con-

sumer-goods industries.

Industrial workers' demand for primary products can be satis-

fied without difficulty. As it is assumed that farmers will not

increase their consumption of agricultural products, there would be a

surplus foods and fuels in the agricultural sector which could be sold

to the city workers. (For simplification, we assume away the problem

of transportation.)

The consumer-goods industries can sell a half (or $5 million)

of their products to their own workers. Demand from the primary

producers will provide the market for the rest of their manufactures.

This is inevitably so by the assumptions made. Farmers have $5 million

of sales proceeds. By assumption, they are not going to spend this

additional income to increase their consumption of foods and fuels,











nor can they save. The only way left open for the farmers is to buy

manufactured consumer-goods. Thus the legage of income out of the

industrial sector is exactly offset by the counter-leakage of the

inflow of income into the industrial sector from the primary sector.

The argument in the several preceding paragraphs shows that,

under a set of special assumptions, the Nurksaan solution of a more or

less simultaneous development of various consumer-goods industries

could overcome the difficulty of the narrow domestic market. A vital

question which must be raised now is 'Bow realistic are the as-

sumptions?" To see how unrealistic the set of assumptions employed

in the preceding paragraphs are, it is not even necessary to examine

all of the assumptions. This study will, for the sake of brevity,

not question the existence of underemployment in rural area, nor will

it question the assumed impossibility of saving.

It was assumed that the consumption of primary products both

by the rural population and the new industrial work force will not

increase during the process of the development of new consumer-goods

industries. This assumption, however, is rather unrealistic for poor

undernourished people of the underdeveloped world. It is more plausi-

ble that hungry rural population will consume at least a part of the

foods which would have been consumed by the members of their families

who left to go to the cities. Likewise, the newly employed industrial

workers' consumption of foods and fuels would tend to be higher than

the shares they had while they were in the rural area in the state of











crypto-uneaployment.

What are the implications of this tendency or propensity to

consume more primary goods which accompanies the program of a

synchronized development of consumer-goods industries? First, it

means that a simultaneous development of a series of consumer-goods

industries taken by itself is not sufficient to provide an adequate

market for the series of industries being developed. In the absence

of concomitant development of the primary sector, and the increase

of purchasing power therein, the leakage into the primary sector of

income created in the industrial sector cannot be expected to be

offset by a corresponding counter-inflow from the rural sector to

the newly developing industries. Secondly, it means that, if the

program of a simultaneous development of various consumer-goods

industries is to be carried out without severe bottlenecks and the

danger of inflation, the primary sector must also be developed,

together with the industrial sector, to meet the increased demand

for primary goods. Thus, not only to secure an adequate market for

the new set of industries, but to meet the added requirement for

primary goods, the development of the primary sector must also ac-

company the development of the industrial sector.

It was assumed that the workers of newly established indus-

tries will delimit their purchase of industrial goods to the products

of the set of new industries. Likewise, farmers who receive their

extra sales proceeds were also assumed to confine their purchase of

industrial goods within the products of the set of industries












for those workers they supplied the primary products. In reality,

however, there are likely to be other industrial goods and foreign

commodities which will attract the purchasing power of the industrial

workers as well as of the agricultural population with its additional

income. Few underdeveloped countries are so underdeveloped that they

do not have any industrial products which are quite widely consumed in

the domestic market. It is also quite difficult to find any under-

developed country in whose market one might not find imported luxury

articles. This leakage into other types of industrial goods and into

the import sector constitutes an additional leakage similar to the

leakage into the primary sector. To offset these leakages, either the

other group of industries and the foreign trade sector must be developed,

or the primary sector must be developed even further. It is most likely

that some development of other industries and the foreign trade sector

is necessary, both to provide the required commodities and to provide

the additional purchasing power to offset the outflow of income from

the newly developing set of industries.

From the above analysis, it is clear that under realistic

conditions the leakage of income from the newly developing consumer-

goods industries into other sectors of the economy will be larger

than the mount of induced counter-inflow of income from other

sectors. The inevitability of this loss of income to other sectors

means, first of all, that a synchronized development of consumer-goods

industries alone will not be sufficient to overcome the difficulty of

the narrow domestic market. Workers in different consumer-goods











industries become each other's customers. But their purchases are

not enough to justify the investment. To provide the newly developing

consumer-goods industries with a sufficient market to justify the

investment, the leakage to the other sectors of income generated in

the consumer-goods industries mest be offset by inflows of income

from other sectors of the economy. In order for this inflow to be

large enough to offset the outflow, there must be not only induced

inflow but autonomous inflow which is created by the autonomous

development in other sectors and the increase in income and spending

thereof. Additional income created by investment in agriculture,

forestry, fishery, etc. -- by increasing productivity and income --

will not only increase the demand for the products of those sectors

but also increase the demand for the industrial consumer-goods, too.

Not only the consideration of the demand situation but also

that of the supply problem requires the development of other sectors.

To meet the increasing demand for foods and other primary products

which is likely to accompany the development of various consumer-goods

industries, the primary sector must be developed. To pay for the

increasing import of consumer-goods and capital equipment, the export

sector must also be developed.


If development of consumer-goods industries can induce enough
investment in the primary sector, the need of autonomous investment in
the primary sector to increase their output might be non-existent.
This, however, is a very unlikely assumption.












From the above discussion, it becomes evident that if we

pursue the implication of the Nurksian concept of balanced growth to

its logical conclusion, it cannot be limited to a more or less

simultaneous development of various consumer-goods industries alone

the concept must be extended to include the development of various

other sectors in order to assure a sufficient market for factory-

produced consumer products. What the logic of the Nurksian argu-

ment requires, then, is not a synchronized development of consumer-

goods industries alone but a more or less synchronized development of

various branches of an economy including, for one, consumer-goods

industries.


Critique on the Income Elasticity of
Demand as the Measure of Balance

In the Nurksian doctrine of balanced growth, the solution to

overcome the difficulty of the narrow domestic market is a synchro-

nized expansion of various factory-produced consumer-goods industries

at the rates dictated by the community's income elasticities of demand.

In other words, income elasticities of demand serve as the criterion

by which "balance" is to be measured.

Nurkse was concerned with the deficiency of the domestic

market demand which deters private entrepreneurs' incentive to invest,

and was proposing the solution of a simultaneous development of various

consumer-goods industries, which is thought to create the market at

the same time it increases production. For Nurkse -- who assumed

private enterprise economy and had a clear picture of the












interrelationship between the increase of productivity and the in-

crease of purchasing power and market demand -- it was very natural

to employ the concept of income elasticities of demand as the cri-

terion of balance.

Private entrepreneurs' major concern is to sell their products

and make profit. If all the entrepreneurs increase their production

with the community's income elasticities of demand for their re-

spective products, they might be assured of the market, and the

difficulty of insufficient market demand might be overcome. As

production increases income and purchasing power increase. This

increased purchasing power will be spent on the purchase of various

commodities according to their income elasticities of demand. The

production, however, was undertaken in accordance with the community's

income elasticities of demand for various commodities. Thus, sales

and production match beautifully, and everything is well.

The income elasticities of demand as the measure of balance,

however, entails some serious difficulties even within the Nurksian

realm of the private enterprise economy. Even an elementary student

of economics knows that demand is determined not only by the absolute

size of income, but also by the distribution of income, by relative

prices, and by the tastes of the population. Thus, if the income


The difficulty due to the leakage of income created in
consumer-goods industries into other sectors of the economy was
already examined in the preceding pages. The consideration of this
difficulty is abstracted here for the sake of brevity.












elasticities are to serve a the investment criterion, it ust be

assumed that (1) relative costs and prices of various goods and

services remain unchanged. (2) the pattern of the distribution of

income is not disturbed, and (3) the tastes of the population do

not change.

All of the preceding assumptions are, however, rather un-

realistic. First, economic development -- especially a balanced

one -- involves the expansion of various branches of an economy.

Supply conditions -- such as the availability of better technology,

of human and natural resources -- in the various branches of the

economy, however, are bound to be different for different industries.

Thus, while some industries might enjoy a substantial reduction of

their production cost, others might be able to reduce their cost only

to a small extent. In still other cases, the producers might even

face increasing cost. Such changes in the cost of production will be

promptly reflected in changes in relative prices.

Secondly, economic development mans the creation of more and

better employment opportunities and the shift of the pattern of

resource uses, which facts are bound to cause some shift in the pattern

of income distribution. Changes in the pattern of income distribution,

even in the absence of any change in the total mount of income

available for spending, will cause changes in the pattern of demand.

For example, a more equitable distribution of income, which mans the

enhancing of the purchasing power of the lower income group, will

produce a greater increase of demand for articles of everyday use,












such as foods, clothing, and inexpensive industrial goods. On the

other hand, if only income of the very well-to-do people is increased

as the result of development process, there will be little increase

in the demand for such everyday articles. The expenditure pattern of

urban populations is likely to be quite different from that of the

rural families. Thus, the shift of the population from rural to

urban work is also bound to create changes in the tastes of the popu-

lation.

Thirdly, economic development means not only increased and

cheaper production of already known goods and services, but also the

production of new as well as better products. But income elasticity

of demand, of course, cannot tell us what will be the demand for a

new product nor what new product an entrepreneur should produce.

Besides, the tastes of the population are more likely than not to

change in the process of economic development which involves all

kinds of changes. If it is not possible to assume a given taste, the

income elasticities cannot explain the demand for various products.

Once we relax the assumption of the closed economy, and con-

sider the case of an open economy, another difficulty of the income

elasticity of demand as the measure of balance or the investment cri-

terion becomes very apparent. How can we determine whether we should

produce a product domestically or import it from abroad? The income

elasticity can give no guide to this important question, and we must

seek the answer from some other criterion.















CHAPTER IV


CRITIQUE OF THE NURKSIAN ASSUMPTIONS


The preceding chapter analyzed and criticized Nurkse's doctrine

in terms of his own assumptions and within the realm of his own analy-

sis. This and the following chapters, however, are free from the

Nurksian restrictions, and examine Nurkse's thesis in the light of

the total framework of capital formation and economic development.

This chapter attempts a critical evaluation of some of the

Nurksian assumptions. First, let us start off with the analysis of

the legitimacy of assuming private enterprise economy in the dis-

cussion of economic development of today's underdeveloped countries.


The Assumption of Private Enterprise

It does not require a lengthy argument to show that the

Nurksian assumption of a private enterprise economy is not appropriate

to an effort to formulate a theory of balanced development which is

to serve as an investment criterion in the economic development of

underdeveloped countries.

It is true that Nurkse was mainly concerned with the demand

problem of private entrepreneurs in his doctrine of balanced growth.

As soon as he introduces the solution of balanced growth, however,

he cannot confine his analysis to the demand side of the problem, nor

can he limit his attention to the private sector of an underdeveloped











economy. The reason why his analysis nuat include the consideration

of supply side will be given in Chapter V. For the present, let us

consider why it is necessary to formulate a theory of balanced

development within the context of a mixed economy in which the private

as well as the public sectors play roles.

Chapter V presents a detailed discussion of why the analysis

of the supply side mut form an integral part of a balanced develop-

ment thesis. Once the supply analysis is brought into the picture, it

tells us that the lack of various forms of extermal economies is a

great barrier to capital formation, and that a balanced development

program should include not only the simultaneous development of various

consumer-goods sectors but also the development of social overhead

facilities as well as various earlier stages of production. To say

that the Nurksian concept of horizontal balance must include the

development of various socio-economic overhead facilities and semi-

public undertakings is to say that the Nurksian doctrine of balanced

growth cannot narrowly be confined to the realm of private enterprise

sector. Thus, though the Nurksian doctrine started out with the

analysis of the demand problem of private entrepreneurs, the nature

of the proposed Nurksian solution makes it imperative that the

Nurksian assumption of private enterprise economy must be supplanted

by an assumption of a mixed economy in which both private and public

sectors have their roles. Furthermore, even if the Nurksian solution


To integrate all the critiques of assumptions in the present
chapter, a conclusion will be anticipated from Chapter V which will be
independently developed at that point.











could be narrowly confined to a synchronized development of consumer-

goods industries, the solution would still require the introduction

of the government into the picture. Without governmental participa-

tion how can a synchronized development of various consumr-goods

industries take place?

The need to formulate a theory of balanced development within

the context of a mixed economy becomes very evident when we consider

the reality of underdeveloped economies. Most of underdeveloped

countries are conspicuous by the absence of innovating entrepreneurs

and of social overhead facilities. Because there are not sufficient

entrepreneurs to undertake various developmental projects privately,

and because there is an acute shortage of various social overheads as

well as seal-public facilities, governments are bound to play leading

roles in the economic development of many underdeveloped countries.

(This is so well known that there is scarcely any need to quote

statistical data to substantiate it.) Insofar as the government as

well as private entrepreneurs are playing important roles in the

developmental process of underdeveloped economies, a theory of

balanced development as the investment criterion in developing

economies must be formulated within the framework of a mixed economy.

A theory -- if it is to be meaningful and significant -- must

be formulated under the set of assumptions which approximate reality

as far as possible without unduly complicating the analytical task.












The Assumption Regarding Demand Conditions

Nurkse has eloquently demonstrated the importance of the

market in the process of economic development. To emphasize the

role of demand in capital formation of underdeveloped countries

was, to be sure, one of the most important contributions of Nurkse's

doctrine. The deficiency of market demand is not only the first

proposition in his argument but also the most crucial element in his

theoretical structure.


The deficiency of market
demand and Say' s Law

Many economists might at first be surprised to hear that

demand for capital could be deficient in underdeveloped countries.

Are not the backward areas in great need of capital for better utili-

zation of their abundant labour and for the exploitation of their

natural resources? But Nurkse explains vividly how the limitation of

consumer demand can produce a deficiency in the demand for capital,

which in turn deters capital formation and economic development in

general. As far as entrepreneurs are concerned, the existence of a

market which assures a reasonable prospect for the sale of their

products is the prerequisite of any capital investment for the pro-

duction of them. The absence of such a market, therefore, discourages

capital formation and produces the deficiency of demand for capital.

By explaining the role of demand and by bringing our attention back

to this crucial problem, Nurkse has done a real service towards a

better understanding of the problem of economic development.












The problem of demand deficiency in poorer countries is very

real for an industrial producer, and the limited size of the market

is a serious brake upon private incentive to adopt modern techniques

of production. There are many instances in which a business venture

turned out to be a failure due to the lack of demand. We have already

referred to some Latin American experiences in which American branch

plants were soon withdrawn because the local market was found to be

too small to make their operation profitable. During post-Korean War

days, Korean textile industries producing coarse cotton sheet found

it impossible to market it at profitable terms. Professors J. George

Robinson and Robert C. Manhart, who are in Seoul under the I. C. A.

aid program to strengthen business education in Korea, are said to

have reported that most Korean producers are operating at below-

capacity levels due to the narrowness of the domestic market.2

The most important factor contributing to this trouble of

demand deficiency is the low level of productivity and real income in

underdeveloped countries, which was clearly emphasized by Nurkse. Low

per capital national income is one of the principal attributes of under-

developed countries. This very low level of income compels them to

spend most of their income on the basic necessities of life and does

not leave much to be spent for the purchase of industrial products.

As emphasized by Nurkse, the deficiency of demand in under-

developed countries is not a deficiency of monetary demand due to
excessive saving but a deficiency of real purchasing power due to low


2Kyunghyang Shinmoon (Seoul, Korea: January 18, 1959), p. 2.













levels of production and income. People are too poor to save and

there is no room for a deflationary gap through excessive saving to

develop. Say's Law was largely discarded in developed countries

today because of the clear possibility that income earned will not

necessarily be spent but saved for the future. But the people of

underdeveloped countries -- being as poor as they are -- lack even

an adequate provision of basic necessities of life, and have little

ability to save for the future. Thus, Say's Law is still quite

applicable in the poverty-stricken underdeveloped world. Demand is

deficient due to the lack of income to spend. The deflationary gap

due to excessive saving is a sheer impossibility.

The applicability of the Say's Law to underdeveloped countries

today basically stems from the similarity of the economic conditions

of the world in which Say lived and those of today's backward econo-

mies. Though Say's Law is invalid as applied to modern, advanced

countries which enjoy higher standards of living, it is not unrealistic

in view of the economic conditions of Say's own time and today's

underdeveloped countries.

Some of the factors which are characteristic of today's under-

developed countries were also characteristic of the economic conditions

of Say's time. For instance, income in the western world of 1803 (in

which Say's Traite d'Eoonomie politique was first published) was not

much higher than that of underdeveloped countries today. The rapid

increase of national income per capital, which ranged between some 13

to 20 per cent per decade in Western Europe and the United States












during the past 100 years, was yet to come.

In a world of low income in which the most urgent wants are

not yet satisfied, saving cannot compete strongly against current

wants. It is a Say's world, in which most income is spent rather

than saved.

Money can either be spent or saved. To accuse Say of neg-

lecting this peculiarity of money, however, is a less serious charge

than if we made it against an economist analyzing developed economies

of today. The economies of western world in 1800 was not yet as

highly monetized and accordingly money was not as important as it is

today. "In the United States of 1840 the quantity of money was 10

per cent of the value of national income; by 1900, 55 per cent; by
4
1940, 85 per cent." The growing possibility of "investing in cash"

and of withdrawing money from purchasing did not exist.

In Say's time a much larger proportion of total output was

made up of consumption goods and non-durable goods. Consumption goods

tend to be bought in a relatively sustained volume.5

Even though in underdeveloped countries Say's Law is valid in

the sense that there is no deflationary gap, it is never valid in the


3
Simon Kusnets, "Quantitative Aspects of the Economic Growth
of nations," Economic DeveloPment and Cultural Chanae. October 1956,
p. 13.
4
Theodore Morgan, Income and 1mplomemnt (Englewood Cliffs,
N. J.: Prentice-Hall, Inc., 1952), 2nd ed., p. 231.
5
no.











6
sense that any single industry can create its own demand. People

are too poor not only to save for the future, but also to purchase

the output of a modern factory. In many underdeveloped countries,

the market for industrial product$ will be even narrower than would

appear from the low figures of per capital national income alone.

There are several important reasons for this.

The first is the fact that the internal market of an under-

developed country is rarely homogeneous and continuous throughout

the country. Not only is it likely to be broken up by disparities

among sectors but in many cases it is likely to be segmented geo-

graphically either by the lack of adequate transportation and com-

munication or by the presence of formidable natural obstacles to the

movement of goods. Furthermore, a large portion of an underdeveloped

country consists of a subsistence agricultural sector which is not

quite monetized and accordingly cannot be counted on as a part of the

national market. Thus, what would be a small market even if it were

a homogeneous well-connected single entity turns out to be no more
8
than a congeries of more or less unconnected fragantary market.

Secondly, extreme inequalities in the distribution of income

characterize many underdeveloped countries. Considering distributions

of family income for India in 1949-1950, for Ceylon in 1950, and for



6Nurkse, on. cit., p. 9; fu ,a Chapter II, p. 15.

7United Nations, Processes and Problems of Industrialization,
ooc.sit, p. 13.

8jlg ., p. 14.












Puerto Rico in 1948, Kuznets concluded that "the data show that

income distribution in these poor countries is somewhat more unequal

than in the developed countries during the period after World War

II.9 Morgan also states that income distribution in underdeveloped

economies, by size, by occupations and by national groups, is more

unequal than in developed economies.10 Such concentration of wealth

and income in the hands of the privileged class -- whose expenditures

are more likely to be for imported luxuries than for coarse products

of local manufacturers (housing being one exception) -- tends to

reduce the extent of the market that a domestic producer can enjoy.

Another factor contributing to the shrinkage of the size of

the market in underdeveloped countries arises from the fact that they

are the late-comers in the field of economic development. Their

small demand for manufactured goods, in the absence of protective

measures, is likely to be supplied cheaply from abroad.3 This ex-

istence of superior competitors abroad further narrows the already

narrow market of an underdeveloped economy and aggravates the diffi-

culties of local manufacturers.

To sum up, Nurkse attached a great importance to the de-

ficiency of market demand as a barrier to capital formation. Such


9Simon Kuznets, "Economic Growth and Income Inequality,"
American Economic Review, March 1955, pp. 20-21.

LOT. Morgan, "Distribution of Income in Ceylon, Peurto Rico,
the United States and the United Kingdom," The Economic Journal,
December 1953, P. 833.

-lpaul Baran, The Political Economy of Growth (New Yorkt
Monthly Review Press, 1957), PP. 174-75.













factors as generally low and unequally distributed income, fragmented

internal markets, and the existence of superior foreign competitors

all tend to reduce the size of the domestic markets of underdeveloped

countries. In view of these many factors which tend to create demand

deficiency, the Nurksian emphasis on the narrowness of the domestic

market should deserve to be acknowledged as a significant contribution

to our understanding of the problems of capital formation in under-

developed countries.


The Nurksian over-emphasis on demand

From Nurkse's exposition as well as from the experiences of

underdeveloped countries, it is clear that the domestic market of an

underdeveloped country is narrow and that this narrowness of market

discourages capital formation to work for the market. But when we

are told that this market deficiency precludes the profitable appli-

cation of capital in any field, we feel a little uneasy. Is it true

that, as Nurkse claims, "the small size of a country's market can

discourage, or even prohibit, the profitable application of modern

capital equipment by any individual entrepreneur in any particular

industry? Nurkse's example of establishing a modern shoe factory

in a poor country, where the people will spend most of their income on

food and simple textiles, persuasively illustrates that a particular

investment might fail due to the lack of the demand for it. This is

a very simple, effective illustration. For the sake of exposition,


10. cit., p. 7 (italics mine).












Nurkse set up a situation in which, by definition, the demand for

shoes is inelastic and investment for a modern shoe factory is bound

to be a failure. But an illustration is illustration and nothing

more than that; it gives no basis for any generalization. When Nurkse

says that any individual project in any particular industry will not

be profitable due to the "inevitable inelasticity of demand"13 he is

actually stepping beyond the legitimate boundary of generalization.

Nurkse, probably in his attempt to present his case forcefully, made

a sweeping generalization for which no firm ground existed. Perhaps,

no one will rigorously defend the hypothesis that there cannot be

any profitable investment project in the absence of balanced growth.

The alleged impossibility of any project simply does not agree with

our observation in underdeveloped countries, where some kinds of

investment are always taking place.

To invalidate Nurkse's generalization, Henry G. Aubrey, for

instance, points out that due to our over-concentration on the problem

of low purchasing power and small markets we tend to overlook the

frequent absence of industries to satisfy visible demand. In

Nicaragua, according to him, four to five million square yards of

plain cotton goods which are now being imported could be made locally.

He goes on to say: "In the absence of modern slaughtering and

processing facilities the local price of crude lard is often higher

than that of meat hence, a large part of consumption is imported.

It may be concluded from these and other examples that the absolute


13Ibid., pp. 9-10.













size of the market is not necessarily the chief limiting

factor "14

The possibility of coat-reducing innovations further reduces

the generality of the insufficiency of market demand. If an entre-

preneur, by the introduction of modern production technique, can

reduce the cost of production of a rather widely demanded existing

good, then the fact that a new plant may reduce the price of the

product and the expected rate of return, will not necessarily dis-

courage the investment.

John Sheahan, in criticizing Nurkse's concept of balanced

growth, even goes further to say that in many underdeveloped countries,

"the problem of weak investment incentives may well be non-existent."15

He contends that if the price at which the shoes may be sold will not

cover the costs of production, the presumption must be that people do

not want them at the prices of the other things they would have to

give up to buy the shoes; and that the trick would seem to be to invest

in production of goods people want at the level of income they will

have when an investment project is carried out.

Just as Hurkse goes to one extreme to claim the inevitability

of the inelasticity of demand for any product in any industry, so

Sheahan goes to another extreme when he claims that the deficiency of


14"Investment Decisions in Underdeveloped Countries," in
Capital Formation and Economic Growth; A Conference of the Uni-
versities--National Bureau Comaittee for Economic Research, edited by
Moses Abraovits (Princeton: Princeton University Press, 1955), p. 424.

150L. ct., pp. 186-89.












market demand does not exist and that the problem could be solved if

entrepreneurs would produce what the people want. To say that the

production of what people want will solve the difficulty of insuf-

ficient market demand in an underdeveloped economy desiring a rapid

growth amounts to saying that there are plenty of investment oppor-

tunities which are not only profitable but also conducive to further

economic growth. In other words, it mounts to assuming away the

difficulty of the narrow market altogether.


A more plausible hypothesis

A more plausible hypothesis concerning the market demand in

underdeveloped countries seems to be neither the inevitability of

inelasticity of demand for any additional product in any industry

taken by itself nor the non-existence of any deficiency of market

demand, but something in between these two extreme positions. The de-

ficiency of domestic purchasing power is an important factor deterring

capital formation in many fields. But it is equally true that there

are some fields in which such demand deficiency is not an important

drag upon additional capital formation.

The crucial question which must be raised now is whether the

kinds of investment which face no market difficulty, and therefore

might be undertaken by entrepreneurs seeking profit, will be those

which are conducive to the general economic development of an under-

developed country. The people's demand, as shown by money votes of un-

equally distributed income, might be a poor guide for investments in

an underdeveloped economy aspiring to a quick economic development.












From the point of view of individual entrepreneurs, investment may be

very rational and profitable in such undertakings as the construction

of movie houses, lipstick factories, luxury-type residential

buildings, etc; but from the point of view of the economy as a whole,

and particularly under the criterion of the external economies sig-

nificance for further economic development, this type of investment is
16
not likely to be of such value.

If it is true that the types of industries which would develop

without being checked by the dificiency of local demand are likely to

be those which satisfy the luxury-type demand rather than the ones

which are basic to the over-all growth of economy, then the problem

of the demand deficiency discouraging capital formation still remains

a very important question. Investment in luxury-type real estate,

movie houses, night clubs, tea rooms, and other luxury items generally

does not contribute much to the further development of the economy.

No external economies of any significance to the cumulative growth of

the economy result from such investments. If a country is to get rid

of the misery of underdevelopment, it must invest in a host of

essential industries which will reinforce each other to acquire a

momentum strong enough to put the economy on the road to cumulative

growth. Essential investment for the economic development of an

underdeveloped country, however, might not be forthcoming due to the

deficiency of market demand. For example, a badly needed bus or

16
1John Adler, 'The Fiscal and Monetary Implementation of
Development Programs," merican Economic Review, Paer ad pro-
ceedings, May 1952, p. 592.












truck line might fail to be established because the demand for such

service might not be large enough to attract private entrepreneurs.

From the over-all economic point of view, the domestic production of

such products as steel, cement, power, and glass might be highly

desirable; but private entrepreneurs might refuse to invest in the

production of these products because the deficiency of the domestic

market does not promise attractive rewards in these areas. For most

underdeveloped countries, the question of the narrow market and

demand deficiency -- though it might not be as important as Nurkse

claims it to be -- seems to remain an important problem which must

be solved if underdeveloped countries are to succeed in their attempt

at rapid capital formation and cumulative economic development.

The proposition that the deficiency of the market demand dis-

courages capital formation is very real when it is applied to indus-

tries but seem to be rather irrelevant when applied to peasant

agriculture. Peasants in underdeveloped countries usually do not

evaluate the market for their products (nor would it be possible

even if they wanted to do so). The things that inhibit capital for-

mation in the agricultural sector are the lack of resources and the

lack of knowledge due to a generally low level of education, isolation

enforced by deficient transportation facilities, and absence (or

nominal existence) of such facilities as an agricultural extension

service.

Will the deficiency of the market demand hinder capital

formation by the government and its agencies, too? As government












enterprises and public works are not guided by the profit criterion,

they will be free from the difficulty of the narrow market.17 The

government can invest, for example, in a power plant without any

regard to the market for the power supply and therefore profit.

But the desirability of a power plant simply does not exist if there

is no potential demand for power by industries and homes. Though

the demand which assures the private productivity of the project is

not necessary, a sort of expected demand which guarantees the social

productivity of the project in the foreseeable future is a necessary

prerequisite of a governmental investment. When a single investment

project is undertaken, however, it is always uncertain whether or not

such demand will spontaneously emerge, and thus the project will be of

uncertain desirability. Thus even in the case of a government in-

vestment, the consideration of demand for it cannot be entirely avoided.

But this is not exactly the same thing as the market difficulty

haunting private entrepreneurs in underdeveloped countries, and might

be better classified as a difficulty mainly due to the lack of comple-

mentary industries and ignorance as to their future development.

To sum up, the deficiency of market demand might not be a

serious difficulty for government investment and peasant agriculture.

The narrowness of the market is, however, likely to be an important

element curtailing private entrepreneurs' inducement to invest for

many industrial caemodities intended for domestic consumption. Nurkse


17If the major purpose of a government enterprise is to
produce monopoly revenue, the market consideration will, of course,
be very important.












was right in attaching an importance to market demand in the process

of capital formation. Nurkse, however, could have stressed the

importance of the difficulty caused by the narrow market and inelastic

consumer demand without going to the unnecessary extreme of claiming

that no individual entrepreneur, no matter what line of industry he

may be in, can escape from this difficulty. If an underdeveloped

country is to develop under the system of a mixed economy, both private

enterprises and government must contribute to capital formation and

economic development. Therefore, the deficiency of domestic demand,

which discourages entrepreneurs' inducement to invest in home indus-

tries, is still an important barrier to the economic development of

underdeveloped countries.


The Income Elasticity of Demand as the Investment
Criterion: Further Critiques

In the preceding chapter in which a critical analysis of the

Nurksian thesis was undertaken within the boundary of the Nurksian

analysis and with the granted acceptance of the Nurkstan assumptions,

it was pointed out that the use of the concept of income elasticity

of demand as the measure of balance required a set of very unlikely

static assumptions. It was shown that to be able to use the concept

of income elasticity as the measure of balance in a developing economy,

we must assume that distribution of income, relative prices, and the

tastes of the population will remain unchanged during the process of

balanced development.

As soon as we emancipate ourselves from the narrow confines












of the Nurksian frame of analysis and consider the income elasticity

of demand as an investment criterion applicable not to the private

sector alone but to the entire economy, a very serious additional

difficulty arises in the use of the concept as the measure of balance

or investment allocation. To employ the income elasticities of demand

as the investment criteria in an underdeveloped economy is to assume

that the price mechanism will ensure the most rational possible use

of the community's productive resources for the cherished rapid eco-

namic development. It is a complete reliance on the Smithian invisi-

ble hand. The well-known existence in underdeveloped countries of

various market imperfections, and of the marked inequalities in the

distribution of income as well as the consideration of various ex-

ternal economies, however, indicates that there should be a consider-

able divergence between private and social productivity of an in-

vestment project, and that the market price is not a sufficient nor

the best guide for investment in underdeveloped countries desiring

rapid economic development.

The lack of knowledge is rather conspicuous in most under-

developed countries. Widespread illiteracy, lack of effective

advertising media, poor communication and transportation facilities,

etc., all contribute to the lack of knowledge of market conditions.

In the absence of a satisfactory knowledge of the market, the income

elasticity of demand cannot serve as a satisfactory investment

criterion. The lack of knowledge distorts the income elasticities

of demand of the population.












It has already been pointed out that the distribution of

income in underdeveloped countries is more unequal than in most

developed countries. This inequality in the income distribution

reduces the value of the income elasticities of demand as the

investment criteria in underdeveloped countries. Money votes shown

by the income distributed unequally are not likely to be satisfactory

guides for investment allocation for a rapid development of the entire

economy.

Our knowledge of the various interrelationships among the

various industries and branches of an economy, and the consideration

of the external economies of all sorts tell us that in the developing

economies of underdeveloped countries many projects are often inextri-

cably tangled together by technological, economic, and social inter-

relationships.18 The successful completion of a given project may

entail the initiation of a host of subsidiary projects, or the

provision of many basic facilities such as hydroelectric power station,

transportation net works, and so on. An undertaking of a particular

project, on the other hand, might preclude the initiation or completion

of other projects which are also of value to the economy. The fact

that many projects are closely interrelated and bound together, thus,

suggests that the private productivity and the social productivity of

various projects might differ considerably and accordingly that the

income elasticities of demand which reflect the private money votes

might be a poor investment criterion for the development of the economy

18See Section 2, Chapter V.













as a whole.

In summary, the concept of the income elasticity of demand

is a rather poor investment criterion for developing economies. Not

only the various forms of market imperfection prevalent in under-

developed societies reduce the value of income elasticities as the

investment criteria, but also the divergence between the private

productivity and social productivity of a project makes it difficult

to employ the income elasticity as the investment criterion in under-

developed economies aspiring for a rapid development.















CHAPTER V


CONSIDERATION OF PROBLEMS NEGLECTED

IN THE NURKSIAN ANALYSIS


The preceding chapter was devoted to a critical analysis of

the Nurksiaa assumption and presuppositions. Our analysis was, thus,

still confined to the problems raised within the Nurksian realm of

analysis. This and the following chapters will, however, be devoted

to the consideration of the problems which were mostly neglected in

the Nurksian analysis, and yet, in the present writer's opinion, are

indispensable considerations in an attempt to obtain any reasonably

complete theory of balanced economic development.1


iThough the terms economic development and economic growth have
been used almost synonymously in economic literature, the term develop-
ment might be more appropriate for underdeveloped economies. The
connotation of the word "growth" suggests a more or less natural and
organic process, while that of the word "development" suggests the un-
folding of the latent possibilities either by themselves or by outside
forces. The concern of underdeveloped countries today is to pull
their economies out of the underdevelopment status and to set off a
cumulative economic progress. They are not satisfied with the natural
rate of slow progress, and are struggling to accelerate the rate of
progress. Therefore, the term development rather than growth seems to
be more suitable for underdeveloped countries. On somewhat different
grounds, Ursula K. Hicks also prefers to use the term development with
underdeveloped countries: "It is convenient to refer to the problems
of the developed countries as concerned with growth, most of their
resources being already known and largely developed, apart from
certain minerals for which uses have only recently been discovered.
The problems of the backward countries can then be regarded as those
of development of hitherto unused sources whose uses in general are,
however, well known." ("Learning about Economic Development," Oxford
Economic Papers, February 1957, P. 1.)












Nurkse's Abstraction from Supply Analysis

Nurkse emphasized the narrowness of the domestic market in

underdeveloped countries as a factor deterring capital formation.

Recognizing the interrelationship between productivity and the size

of the market, he proposed a more or less simultaneous development

of various consumer-goods industries as the solution to overcome

the difficulty caused by the narrow market. One of the most serious

shortcomings of the Nurksian doctrine of balanced growth, however,

lies precisely in this very framework of the Nurksian analysis. The

Nurksian doctrine stands on a one-sided consideration of the problem

of capital formation. In his effort to emphasize the role of demand

and to present his thesis in a persuasive, clear-cut form, he con-

sidered only the demand side of, and neglected the supply side of the

problem of capital formation. Balaned growth, or moreor r less

simultaneous growth of various consumer-goods industries, however,

cannot be proposed on the basis of the one-sided consideration of

demand alone. The demand and supply sides of the problem of capital

formation are closely interrelated. Policies devised to remedy a

difficulty on one side of the problem are often likely to affect the

other side of the problem, or even likely to depend on remedial

measures on the other side of the problem. Due to this inter-

relationship between the two sides of the problem of capital formation

a one-sided consideration of either demand or supply side alone is

likely to be defective. In later pages, it will be shown that this

is exactly the case with the Nurkaian analysis. But, for the present,












let us turn to a substantiation of the rather serious charge we have

made against Nurkse -- that his analysis is a one-sided consideration

of the demand side alone.

In his reply to Marcus Fleming (who criticized Nurkse's

doctrine in respect to limited factor supply2) Nurkse said that the

first chapter of his Problems of Capital Formation -- in which the

doctrine of balanced growth had been advanced -- intentionally dealt

with "investment incentive alone"3 for the sake of orderly discussion.

He goes on to say, "later chapters deal with the supply side not only

in terms of elasticities and propensities, but especially with refer-

ence to -- national and international -- policy measures relating to

the supply of capital. ." In his book, too, Nurkse makes several

remarks to the effect that though the supply side is intentionally

abstracted in the first chapter, it is dealt with in later chapters.'

The fact that Nurkse discusses problems of saving, availability of

capital and the importance of social overhead capital in later

chapters is not disputed. What is at dispute is whether his dis-

cussion of the supply side in later chapters can form an integral

part of his doctrine of balanced growth. If his examination of the

problem of saving and the availability of capital in later chapters

pcfit., pp. 241-56.

3"Balanced Growth on Static Assumptions," op. cit., p. 367.

SIbid.

5Problems of Capital Formation, op. it., pp. 11, 13, and
30-31.












showed that "any inelasticity in the supply of capital" could legiti-

mately be assumed away, then his proposal of simultaneous development

on many fronts will be consistent with his analysis of the supply side

of the problem; and he may rightly claim that his doctrine abstracted

from the side of supply for an orderly discussion. But what his dis-

cussion of the supply side actually revealed was not the abundance

but the scarcity of savings and capital and the need to increase them

doamstically and internationally. This does not fit into the framework

of Nurkse's doctrine which assumes away any inelasticity in the supply

of capital. Thus, it is legitimate to say that Nurkse's study of the

problem of supply fails to be a consistent part of his doctrine of

balanced growth. As far as his doctrine is concerned, it is based on

the one-sided consideration of demand and neglects the side of supply.

In fact Nurkse himself admits this shortcoming: "My framework .

undoubtedly has its shortccmings. Thus balanced growth enters only on

one side of the picture and takes an increased capital supply for

granted."6


The Lack of Ixternal Economies
and Balance in Supply

Nurkse, posing the question in terms of the deficiency of the

demand for capital, concentrated on the demand side of the problems

of capital formation. Being concerned only with the demand side of

the picture, he naturally emphasized the horizontal balance or the

6"Balanced Growth on Static Assumptions," op. cit., p. 367.












complementarity of various consumer-goods industries. The diffi-

culties which hinder capital formation, however, are not limited to

the demand side alone. There are equally, if not more, important

barriers to capital formation on what might be regarded as the

supply side. Even though one knows that there is a wide market to

justify a greatly increased production of a certain commodity, its

supply cannot be increased rapidly in the absence of the various

supply conditions favorable to the increased production. Thus, a

theory of balanced development which proposes a more or less

simultaneous development of various branches of an economy cannot be

complete without a close examination of the problems raised by the

very attempt to develop the economy on many fronts. Though -- in

view of the close interrelationship of the demand and supply

sides -- it is not easy to classify an economic problem as that of

the demand or supply side alone, we might designate the problems

raised by the attempt to develop an economy on many fronts as problems

of the supply side, inasmuch as they are the problems caused by the

attempt to increase supply on various fronts.

Two central problems of the supply side which require close

examination in connection with an effort to develop a balanced develop-

ment thesis are (1) the lack or shortage of social overhead capital

and other interrelated industries which give external economies, and

(2) the supply of capital and resources in underdeveloped countries.

The two problems on the supply side are similar in that the lack or

shortage of either of them means a technical impossibility of












production or a high cost of production.7 The implications of the

two problems for a balanced development thesis are, however, very

different. Let us, first, start off with the analysis of the questions

raised by the lack or shortage of external economies.

Many students of economic development have recognized the

importance of external economies, a concept which was made familiar

to us by Marshall. Soitovsky, Adler, Fleming, Kindleberger, Hughes,

and a host of other economists stressed the importance of external

economies in economic development. The concept of external economy

used by modern students of economic development is usually broader

than Marshall's economies external to a firm, and includes economies

external to an industry, too. Our consideration will also be within

this broader framework.

Inducement to invest in underdeveloped countries may be

insufficient due to the lack of social overhead facilities and of re-

lated industries which provide external economies. This proposition


7At first glance, one might think that the questions of ex-
ternal economies and the supply of capital and resources are quite
different questions: Isn't the question of external economies con-
cerned with the cost of production for private entrepreneurs, while
the question of the supply of capital and resources is concerned with
the absolute limit of production attainable by the entire economy?
The lack of external economies, however, means not only high cost of
production but a technical impossibility of production without pro-
viding the lacking, but required external economies. Resource en-
domment does give a limit to the extent of total production. How-
ever, even though a country lacks, or is short of, a particular re-
source, she can -- war aside -- always import thea from other parts
of the world, provided she is willing to pay the high cost of doing
so. Here again, the important thing is the cost. The economic
significance of the limitation of resources lies in its effect on
the cost of production.











is a counterpart on the supply side of Nurkse's thesis that inducement

to invest is insufficient due to the lack of market demand. Modern

economic society is based on a division of labour. Each branch of

the economic system turns out a part of the finished products or

performs one or a few steps of the intricate production process,

Bach is but a specialized component of the larger economic unit, i.e.,

the national economy. The counter-part of this far-reaching division

of labour is the thoroughgoing interdependence of all elements of

the economic system; production of any commodity heavily depends on
8
the productive activities of the others. The development of the

final stage -- producing consumer-goods -- usually requires the

existence (or simultaneous development) of various earlier stages

supplying producers' goods. The importance to the consumer-goods

producers of the earlier stages of production supplying energy, raw

materials, intermediate products, and services such as transport is

obvious. Without such earlier stages of production, the consumer-

goods stage cannot exist, and vice versa. It is also clear that

such complementary relationship might exist among various stages of

producer-goods producers themselves.

In economically advanced countries, a new firm or industry

will benefit from those cost-reducing services which an established

economic society supplies in the form of communication and transpor-

tation facilities, housing, power and water supplies, a literate

8
Lewis H. Bean and Marvin Hoffenberg in a review of
Mandelbaum's Industrialitation of Backward Areas, The Review of
Economics and Statiscs, November 1948, p. 319.












population susceptible to economic inducements, skilled workers,

managers and engineers, highly organized labour and capital markets

and so forth. But underdeveloped countries are conspicuous by the

very absence of these essential preconditions of economic progress.

An entrepreneur who is starting a new line of production in under-

developed countries has to incur additional cost and risk to overcome

the lack of those external economies which are taken for granted in

advanced economies. Be has to incur additional expenses for which,

while conferring advantages on those to follow, he will not be

compensated.

It is often said that in underdeveloped countries capital is

scarcer and therefore, other things being equal, its marginal produc-

tivity is higher. But this comparison is improper because of its

eeteris paribus clause. Other things are not equal not only because

adequate market demand is lacking, but also because external economies

in existence and in the making are not the same as in developed

countries.10 The additional troubles, uncertainties, and financial

burden due to the lack of external economies are likely to discourage

(as does deficiency of the market demand) capital formation by

individual entrepreneurs seeking profit.


98ee John H. Adler, op. cit., pp. 586-92j K. Mandelbaum, The
Industrialization of Backward Areas, Institude of Statistics Monograph
No. 2 (New Yorks Kelley & Millman, Inc., 1955), P. k; Alfred E. Kahn,
"Investment Criteria in Development Programs," Quarterly Journal of
Economics, February 1951, p. 57; Louis B. Bean and Marvin noffenberg,
op. cit., p. 319.

10Cf. John H. Adler, op. eit., p. 590.












For example, in advanced countries, if a farmer decides to

mechanize his farm, all he has to do is to purchase a tractor and

other agricultural machines suitable to his land and crops. The

information as to what is suitable is readily available from his

neighbors and from such organizations as the agricultural extension

service and firms supplying agricultural machinery. He does not have

to worry about fuel supply nor about repair and maintenance services.

All these valuable services are readily available to him. A farmer

in underdeveloped countries who wants to mechanize his production,

however, cannot find these external economies to rely on. Prior to

the purchase of agricultural machinery, he may have to investigate

and perhaps experiment to discover what types of machinery are most

suitable to his land and crops. He is most likely to have to provide

for his own transportation of fuel, since it is unlikely that a

regular supply service is available. Besides, he has to train his

own machine operators and arrange for his own repair and maintenance

facilities. The lack of all these external economies which, in

advanced economies, are readily available at much lover costs imposes

additional financial burden and worry, and is likely to discourage

the farmer's attempt to invest in machinery and modernization.I

In the ease of manufacturing industries, the situation is

similar. In developed countries, an entrepreneur who decides to under-

take a new enterprise can usually avail himself of the external

economies of continued supply of raw materials, parts, power,


3lTbid.












transportation and marketing facilities, a trained labour force, relia-
12
ble managerial and supervisory personnel, and so forth* But in

underdeveloped countries, an entrepreneur, before he can start an

industrial project, must ascertain the availability of these external

economies which are necessary for his production but often go beyond

his financial capability. Thus, the lack of these external economies

often makes an attempt at new capital investment an impossibility,

Such indispensable quasi-public facilities as power and water supply,

and transportation facilities as well as related industries which

supply or purchase various stages of intermediate products might be

lacking. Further, training of labour and managerial personnel,

maintaining of larger stocks of raw materials and finished products,

arranging for the distribution of the products, etc. might be too

burdensome and costly.

It must be noted that the lack of external economies is a

barrier not only to private investment but also to capital formation

by the government. The lack of social overhead facilities and of

related industries means that often an effort to develop a particular

industry will be -- in the absence of an accompanying development of

necessary social overheads and related industries -- a technical

impossibility. For example, the development of an aluminium plant

(whether this is done by the government or by a private entrepreneur)

is not possible in the absence of the supply of cheap electric power

and transportation facilities. If the government decides to furnish


1 hd., P. 591.












the necessary external economies -- in this case, electricity and

transportation -- the aluminium plant will become a technically

feasible project. The creation of additional external economies, how-

ever, means an additional capital requirement. If the government is

short of capital, the project might still become infeasible. Even

though the capital is available, other things being equal, the higher

the cost of development the less unattractive will be the proposed

project. Thus, it is clear that the lack of external economies deters

not only private entrepreneurs' investment but also the government's

effort on capital formation.

Many economists believe the role of external economies to be

strategic in the process of economic development. According to Adler,

external economies are "an essential prerequisite for an acceleration

of the rate of economic development"1 3 Be even goes on to say that

the present differences in the stage of economic development of

various countries perhaps can be explained more adequately by investi-

gating why in soe countries external economies did cae off while in

others they did not materialize.4 Recognizing the importance of ex-

ternal economies, Norman S. Buchanan says "transportation, communi-

cation and marketing facilities are perhaps the most productive form

that real capital formation can initially assume in the low income

areas." 1 Kindleberger, on the same ground, also mentions his


13Ibid., p. 588. -4 p.P 587.

15orman 8. Buchanan, "Deliberate Industrialization for Higher
Incomes," The Economic Journal, December 1946, p. 541.












"predilection for transport and education as top priorities."6 It is

also on this ground that several economists insist that the concept of

investment in underdeveloped countries must include such expenditures

as cost of technical training, health service, eto.17 Nurkse himself,

though in a different context, stressed that the lack of basic

services such as transport, power and water supply is a serious

bottleneck in the poor countries, and is unfavorable to private invest-

eat.18 According to Nurkse the lack of domestic demand was the main

reason why the private foreign investment of advanced countries in

underdeveloped areas has been mainly confined to extractive industries

and not to industries catering to the domestic markets of underdeveloped

countries. Pursuing much the same line of argument on the supply side

Adler says:

It is this lack of external economies which presumably is
more responsible than any other factor for the limited volume of
small and medium-sized foreign investment in underdeveloped
countries; or conversely, it may be considered as one of the main
causes for the fact that private foreign investment has been
concentrated in large-scale enterprises which compensate for the
lack of external economies of the industry through the horizontal
and vertical integration of the processes of production.19

It follows directly from the understanding of the importance


1 cit., p. 166.

17See, for example, Adler, op. cit., p. 585; Richard Goode,
"Adding to the Stock of Physical and Human Capital," American Economic
Review Papers and Proceedings, May 1959, pp. 147-48.
18"The Problem of International Investment Today in the Light
of Nineteenth Century Experience," op. cit., pp. 754-55.

19Ibd., p. 591.












of external economies as a factor determining the rate of economic

growth that the very lack of them in underdeveloped economies slows

down the rate of capital formation and economic development. The

existence of external economies is, as emphasized by Paul Baran, not

a sufficient condition of economic growth,20 but it is also obvious

that without it rapid economic growth can hardly take place.21

The solution to overcome the difficulty caused by the lack of

external economies in supply is the development of various comple-

mentary stages of industries and social overhead facilities. In the

absence of required external economies, an investment project must

often be accompanied by a more or less simultaneous development of

various complementary stages of industries and social overhead

facilities. The development of an aluminium plant, for example,

requires the construction of a power station which can supply cheap

power. The development of a coal mine might require the development

of transportation facilities which can facilitate the movement of men

and capital to develop the mine, and of the coal out of the mine.

Of course, the development of various complementary industries

and social overhead facilities does not have to take place simul-

taneously in the literal sense of the word.

In the Nurksian argument for horizontal balanced development

0. cit., p. 191.

21or a couple of almost ubiquitous examples in the literature
of the importance of external economies, see I. B. R. D.'s The
Economic Develolpent of Guatemala, p. 98, and The Economic Development
of Iraq, p. 300.













of various consumer-goods industries, the simultaneity plays a rather

fundamental role. According to Nurkse, one industry developed by

itself is likely to be a failure due to the lack of demand which in

turn is caused by the poverty of the people. When a series of con-

sumer-goods industries is created more or less simultaneously,

however, not only various final products but income with which to

purchase those products are created, too. Thus, in Nurkse's model of

horizontal balance, the fact that various industries are developed

more or less simultaneously is essential in overcoming the difficulty

caused by the narrowness of the domestic market.2

In the solution to overcome the difficulty caused by the

lack of external economies, however, the term "more or less simul-

taneously" carries lesser weight. It is preferred but not necessary.

For instance, often the development of social overhead facilities

such as transportation and communication networks will come first.

In some cases, the development of transportation facilities will be

a prerequisite to the development of various industries and primary

production. For example, the development of a cement plant might


SThis Nurksian argument for simultaneity, of course, depends
on Nurkse's somewhat over-exaggerated notion of demand inelasticity
in underdeveloped countries. The reader may recall that we found in
Chapter III that to assume an inevitable inelasticity of demand for
any industry is not realistic nor necessary. Thus, if we relax the
Nurksian assumption regarding the demand conditions and take the more
realistic position that there are some industries to which demand
inelasticity is not an important barrier, then the importance of the
simultaneity phrase is somewhat reduced even in the case of the
horizontal balanced development. There are some consumer-goods
industries which can develop without the simultaneous development of
other consumer-goods industries.












have to be preceded by the development of road and/or railroad

facilities.

It might, however, be assumed that the less a completed

facility has to stand idle the more will be its contribution to the

economic development of a nation. The shorter the time the railroad

is left idle before it can transport coal, the greater will be the

contribution of the railroad to the economic development. In the

case of private entrepreneurs, it is obvious that few entrepreneurs

will invest to establish industrial facilities if they are uncertain

of the development of the complementary facilities on whose emergence

depends the profitabilities of their projects. Under such circus-

stances, the prior existence, or a more or less simultaneous

development of complementary industries is likely to be a necessary

condition of private investment.

Furthermore, the fact that the development of various final

stages of production (horizontal balance) is closely related to the

provision of various earlier stages of production and social over-

head facilities seems to offer a logical argument for a more or less

simultaneous development. We have seen that to overcome the difficulty

of demand deficiency, horizontal balanced development was necessary.

Horizontal balanced development, however, is not likely to be suc-

cessful in the absence of the development of related earlier stages

of production and various socio-economic overhead facilities. Thus,

to assure a successful horizontal balanced development -- if not for

other reasons -- a more or less simultaneous development of social












overhead facilities and related industries seems to be necessary.

The more or less simultaneous development of various stages

of industries and social overhead facilities might be named -- in

parallel to the Nurksian "horizontal balance" -- "vertical balance."

The Nurksian argument for horizontal balance can easily be translated

into an argument for vertical balance. A project which, taken by

itself, looks dubious and uneconomical due to the lack of complementary

industries in the vertical sense -- whether forward from supplying

industries to using industries, or backward from using industries to

supplying industries -- would become an economical undertaking when

it is accompanied by a more or less simultaneous growth of comple-

mentary industries.

The lack of external economies in underdeveloped countries

might mean that a venture in any single enterprise might become

attractive only if the simultaneous development of other comple-

mentary industries is undertaken. For example, investment to build

electric light and equipment industries could become profitable only

if electric power plants were simultaneously built, or were already

in existence. In the sae way, a welding shop can operate con-

tinuously and profitably only if a reliable supply of electricity

or copresr.c oxygen gas exists. An entrepreneur looking at a power

plant or an electric equipment factory as a single venture may be de-

terred from going ahead by the uncertainty as to whether these com-

plementary industries will in fact develop and thus make profitable what

would otherwise be a dubious undertaking. If the two complementary












industries are joined in a single program of development the risk

will be reduced and the profit expectation justified. In the real

world, such complementary relationships will exist among many indus-

tries in many complicated ways. Such a complementarity among industries

is the very basis on which the case for vertical balance rests.

We have given the name "horizontal" to the complementary

interrelationships among various consauer-goods producers, and

"vertical" to the complementarity among various stages of production

and overhead facilities. The distinction between horizontal and

vertical balance, however, is not always easy in practice. For

instance, the interrelationship between a tire factory and a bicycle

factory will be not only horizontal but also vertical. They are

horizontally interrelated in the sense that income earned from both

factories might be spent for the products of each other. At the same

time, they are vertically interrelated because the tire company sup-

plies its product for the bicycle company, and the tire company buys

bicycles for the transportation of its product. The complicated

interrelationships among various components of an economy is well

illustrated in the following quotation from a statement by the Afghan

Minister of National Economy defending his application for credit from

the Export-!~iort Bank.


23
Cf. William W. Lockwood, The Economic eveloment of Japan
(Princeton, New Jersey: Princeton University Press, 1954), p. 227;
Tibor Scitovsky, "Two Concepts of External Economies," Journal of
Political Economy, April 1954, pp. 148-49.












The textile mill project depends upon (a) increased cotton
cultivation and (b) expanded electric energy and fuel supply
and (c) improved and expanded transportation services. A switch
of arable land to cotton and sugar makes necessary increased
production of grains, fruit and legumes in the Arghandab and
Helmand Valleys. Cement and brick production are an economic
asset to the irrigation and construction projects. Similarly,
new sources of electric energy and coal are essential to the
new textile, cement and brick plants. Finally, increased pro-
duction of fruits, cotton and meat for domestic consumption as
well as for export will intensify the ability of the Afghan
economy to repay the hoped-for loan. Clearly, the proposed
projects are largely complementary to each other, so that the
withdrawal of one makes the others suffer.

In summary, our analysis shows that external economies re-

sulting from the complementary interactions of different industries

are not confined to consumer-goods sectors; they are as important, if

not more, in the case of vertical interrelationship among the various

stages of production. Furthermore, the horizontal and vertical ex-

ternal economies interact between themselves. Thus, if we pursue --

extending the logic of the Nurksian thesis -- a solution to overcome

the difficulties both of the narrow market and of the lack of external

economies, the answer seems to lie in a horizontal and vertical balanced

development, i.e., a more or less simultaneous development of various

branches of an economy at various stages of production.

In the preceding discussion of the case for horizontal and

vertical balanced development, we have implicitly assumed, for the sake

of simplification, a closed economy. When we discard this assumption


2 uoted in Michael Belshaw, "Operational Capital Allocation
Criteria for Development Planning," Economic Developent and Cultural
Chane April 1958, P. 200, and P. Franck, "Economic Planners in
ghnistac," Economic Development and Cultural Change, February 1953,
p. 324.












and introduce an open economy, the need of horizontal and vertical

balance of an economy is considerably reduced.

Let us first examine the case for horizontal balance. If the

export of industrial products can pay for the necessary import of

primary products, then industry can develop without a concomitant

development of the primary sector. In the same way, if expansion of

primary production can pay for the import of industrial commodities,

the primary sector may develop without a simultaneous development

of the industrial sector. Thus, it is clear that international

transactions will reduce the need of horizontal balance.

It must, however, be emphasized that even though international

trade reduces the need of horizontal balance, it does not eliminate it.

For many reasons, the expansion of primary production alone is not a

very promising line of development. To expand industrial output and

to compete in the world market with the advanced countries are not

likely to be easy for most underdeveloped countries. Despite the

possibility of international trade, most underdeveloped countries

will find it necessary to maintain horizontal balance among various

economic sectors. In most cases, neither industry nor the primary

sector alone, but both industry and primary sectors will be required

to be developed.

The need of vertical balance is also substantially reduced

when an open economy is introduced. Technically and financially


25
The next section elaborates the need of balance among
sectors.