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Economic development is a multifaceted concept with no universally agreed-upon definition. It broadly refers to a process of economic transformation leading to increased levels of prosperity in a region or country. While increased prosperity is typically associated with increases in per capita income in the region or country of interest, development is considered to encompass more than income. Because of the insufficiencies of a simplistic definition of development based solely on income per capita, new approaches such as “human development” or “capabilities” have been envisioned. Despite these critiques, per capita income level remains the most popular metric for economic development, as it is highly correlated with other indicators commonly believed to characterize development. Thus, even if usefulness of income per capita as a proxy for economic development is often challenged, it continues to be the indicator most frequently used by scholars, policy makers, and international organizations.

Economic development became a major concern in the post–World War II (1939–1945) era following the process of decolonization that led to the emergence of many countries with low living standards; these countries were categorized as “underdeveloped” or “developing” countries, in contrast to “advanced” countries. Although the general tendency has been to lump these countries together in the same “developing countries” category, the World Bank disaggregates this category into “low-income,” “lower middle income” and “upper middle income” categories. There is substantial variation amongst these countries with respect to their resources, sociopolitical structures, and institutional arrangements. These differences, in turn, lead to varying outcomes regarding economic development.

Since the post–World War II era, there has been notable cross-country variation in development outcomes: Some countries, especially those in East Asia, have almost converged into the category of advanced countries, while many in Africa, Latin America, and Southeast Asia have lagged behind.

Theories of economic development were initially set forth by economists in the subfield of development economics, which emerged in the 1950s. Undermining the differences between developing countries, these theories aimed to explain causes of underdevelopment while offering models of development. For many years, the field of political science largely viewed economic development as an exogenous determinant of political institutions and processes. A dominant perspective was that economic development was causally prior to democracy. For the last three decades, however, political scientists have increasingly studied factors explaining variation in the levels of economic development and increasingly focused on political and institutional determinants of economic development.

There has been considerable interaction between development strategies implemented by developing countries and the scholarly debate on development. Changes in development thinking and shifts in policy making are usually reflected in and affected by international organizations such as the United Nations (UN), the International Monetary Fund (IMF), and the World Bank.

First Wave Of Development Thinking And Practice

In the post–World War II context shaped by the conditions of the cold war and decolonization, the dominant belief was that the newly emerging nations were different from the developed nations in their social and economic institutions, and economic development needed to be stimulated. Dominated by economistic approaches, the prevalent perspective in this era was the “big push,” or “take-off ” for economic development. Formulated by Rosenstein-Rodan in the 1940s, the big-push thesis suggested synchronized investment in key sectors in order to overcome indivisibilities and external economies and trigger a momentum for growth. A similar argument was developed further by Nurkse (1953), who underlined a vicious cycle of low saving, low investment, and low income in developing countries. Nurkse suggested a theory of “balanced growth” and pinpointed foreign aid to close gaps of savings, foreign exchange, and skills. According to Rostow’s (1960) view of take-off, developing countries would replicate what the advanced countries had done in order to take off from a traditional society to an industrial one, which would bring about a massive structural transformation of both economy and society. The Rostowian view substantially influenced policy making regarding both project design in developing countries and aid programs offered by the advanced countries.

These views were closely affected by the Keynesian growth models, the most influential of which was the Harrod–Domar model developed in the 1930s and 1940s. Originally developed for conditions of growth in industrial economies, the Harrod–Domar thesis argues that aggregate supply and demand need to increase simultaneously at the same rate in order to maintain full employment and price stability. Hence, in order to sustain investment, if the private sector cannot grow fast enough, the public sector needs to compensate for this weakness, and this has an important policy implication about the role of the state in development. As capital accumulation and industrialization were considered prerequisites of economic development, the Harrod–Domar thesis was applied to developing countries.

Triggering the industrialization process became a major concern for scholars and policy makers alike, signified by the models of Rosenstein-Rodan’s (1943) big push, Nurkse’s (1953) balanced growth, Hirschman’s (1958) unbalanced growth and linkages, Rostow’s (1960) take off, and Gerschenkron’s (1962) great spurt. These models influenced policy making and helped structure import substitution industrialization (ISI) strategy, which was based on the production of consumer goods for the domestic market by using import and exchange controls and reliance on state intervention and planning. Implemented in most developing countries between the 1950s and the 1980s, the ISI regimes were dominated by export pessimism, justified through Bruno and Chenery’s (1962) two-gap model. The big-push and take-off models have been critiqued on several issues, most important of which is their—implicit or explicit—association with state intervention and central planning that, in practice, triggers the push, giving rise to major coordination failures.

The Marxist perspective on economic development also offered inward-looking models for less developed countries (LDCs). It argued that the issue of capital accumulation could not be divorced from the country’s links with the international economy and that the main culprit behind underdevelopment was the structure of international trade. A theory that later came to be known as the Prebisch–Singer thesis was that deterioration of less-developed countries’ terms of trade vis-à-vis advanced countries caused perpetuation of underdevelopment. This view suggested that economic dependence caused by colonization and/or incorporation of nonindustrialized countries into the world economy impeded growth in the LDCs. The dependency view was developed in the 1950s and 1960s by leading experts at the UN’s Economic Commission for Latin America (ECLA) and its Conference on Trade and Development (UNCTAD), such as Singer, Prebisch, and Myrdal.

The UN has been active through its respective agencies in development-related areas since the 1950s.The ECLA affected development thinking substantially in the 1950s and 1960s by initiating and spreading the dependency approach and inward-looking development strategies. UNCTAD was established in 1964 to accelerate economic development in the LDCs and triggered the formation of G77 (a loose coalition of seventy-seven nations) as a lobbying group of the LDCs, which challenged the hegemony of the advanced countries in making the rules governing the international economy.

Early waves of the development thought underlined “market failures” in developing countries, which provided a rationale for the state’s active involvement in planning to overcome these failures. This rationale being strengthened by arguments over issues such as structural weaknesses and limited entrepreneurship, recommendations for development were centered around state action. The state, then, would ignite industrialization and facilitate structural transformation by take-offs, great spurts, big pushes, or balanced growth. This emphasis on the role of the state in development coincided with the postwar consensus in advanced countries about the state’s role in economic activity with respect to Keynesian demand management and regulation of markets.

Second Wave: “Getting The Prices Right”

The second wave of development thinking was dominated by neoclassical analysis. Shortcomings of central planning and state intervention to correct market failures were delineated as early as the late 1960s and early 1970s, as empirical evidence accumulated that there were crises in planning. Then the focus of critiques shifted toward government failures signified by bureaucratic weaknesses, coordination failures, and mislocations. Critiques of the ISI regime referred to high costs of protectionism, rent-seeking activities, deadweight losses, aggravating unemployment, and foreign exchange crises. Neoclassical critique of the first wave of development thinking underlined government failures that distorted the prices, and “getting the prices right” became the new motto. Timmer (1973) asserted that getting prices right would not necessarily guarantee development, but getting them wrong would call for the end of development. Hence, rather than structural conditions, policy making became the center of analysis to explain variation in development. Challenging the distortions in incentive mechanisms in addition to prices, Krueger (1986, 62) stated that the market failures resulted from “inappropriate incentives rather than nonresponsiveness.”

Neoclassical resurgence in development thinking was coupled with the shift to supply-side economics in advanced countries, which entailed a substantial critique of Keynesianism. It was furthered by the emergence of the debt crisis in the 1980s, which was perceived as the indicator of the ISI’s failure. The so-called East Asian miracle based on export-oriented development provided empirical evidence for critiques of inward-looking strategies. The new policy recommendation, then, became export promotion, liberalization of foreign trade regime, and privatization.

Starting from the 1980s, international organizations’ policy advice for the LDCs reflected the neoclassical resurgence in development thinking. Initiated in 1979, the World Bank’s structural adjustment programs (SAPs) aimed to provide loans for structural change in LDCs, with strict conditions: The loans were to be used to implement stabilization measures required by IMF standby agreements and supply-side measures. Conditionalities attached to funds provided by these organizations played a major role in a sea change in development thinking and policy making, resulting in a major shift from ISI to market liberalization in most of the developing countries. SAPs and their one-size-fits-all policy prescriptions to developing countries—prescriptions that included liberalization, stabilization, and privatization— have been subject to fierce criticism that they were either ineffective or even aggravated the existing problems in those countries. SAPs have been more effective in countries equipped with better institutional arrangements, which facilitate a better implementation of the suggested policies.

Third Wave: “Getting The Institutions Right”

Propounding a major critique on neoclassical approaches as undermining institutions and their impact on development, institutional approaches emphasize that free markets are not sufficient for successful economic performance in general and for development in particular. Underlining the need for “getting the institutions right,” this perspective analyzes the role of institutions in economic development based on the premise that often the overextended state structures in developing countries are not capable of creating the institutions vital for development, such as property rights.

Since the late 1980s, the institutional perspective has become dominant in development scholarship across disciplines. As the causal priority of institutions became the central emphasis, links between various institutions and economic development have been drawn. New institutional economics (NIE) played a central role in marrying the institutions with economic development. Focusing on microfoundations of institutional arrangements, NIE suggests institutional arrangements determine the structure of opportunities and constraints on individual behavior; they shape the incentives, and, therefore, mold the business climate.

The institutional framework in developing countries tends to be weaker than in advanced countries, indicating “institutional failures” rather than market or government failures. As Acemoglu and Johnson (2004, 2) state, “The question of why some societies are much poorer than others is closely related to the question of why some societies have much ‘worse economic institutions’ than others.” Historically, institutions in developing countries did not follow the pattern that had been followed in early modern Europe; hence, more impersonal and complex institutions did not emerge. Rather, what Bardhan (2001) calls “bad” or “dysfunctional” institutions persisted in developing countries, determining the path of development.

A widespread consensus has evolved about the role of certain economic institutions on development. According to the institutional perspective, markets “must be accompanied by institutions that limit economic intervention and allow private rights and markets to prevail” (North and Weingast 1989, 808). Thus, institutional arrangements that maintain credible constraints on the rulers in order to sanction opportunistic behavior are conducive to economic growth. Comparative historical analyses pointed out the emergence and persistence of institutions that maintained credible constraints and diminished transaction costs, uncertainties, and coordination failures.

Variation among the institutions regarding property rights and contract enforcement help explain the differences with respect to determinants of economic development such as income level and the rate of growth and investment. Additionally, institutions that resolve collective action problems, and those facilitating credible commitments and accountability, are among those most commonly studied and advised for initiating or accelerating economic development. Bureaucratic institutions are also linked to economic growth, as studies show that competent bureaucracies enhance state capacity and facilitate economic development.

A central institutional weakness in developing countries is the inadequacy of financial markets. Institutions of credit were poorly developed, suffered from access limited to few in the society, or could not catch up with the institutional transformation that early modern Europe went through. Development banks were instituted by the states to fill in this gap in financial markets, but they were not as effective in many developing countries as they were in East Asia, where the state enhanced the market rather than replacing it and prevented coordination failures.

A recent focus in the institutional approach is to analyze power relations and distributive conflicts among different groups in the society with respect to shaping institutional arrangements. Studies show that economic growth is fostered by participation in economic activity and relatively equal access to economic and political resources by a broad base of society. Likewise, unequal distribution of wealth and power may impair institutional changes that would be conducive to economic development. Therefore, allocative qualities of political institutions also matter for development outcomes, and this finding has important implications for elucidating the links between democracy and development.

Democracy and its links to economic development have been widely debated. Earlier argument, inspired by modernization theory, was that economic development preceded emergence of democratic institutions. This argument was entrenched by canonical studies such as those of Lipset (1959, 1975), Lipset and Rokkan (1967), and Dahl (1989), who argued that enhanced economic benefits for the masses foster democratic aspirations and, thus, the demand for democracy.

Recent studies, however, question this earlier belief on the causal primacy of economic development to democracy in two different ways. The first suggests that economic development has no causal effect on democracy or authoritarianism but demonstrates that democracy and income per capita are correlated, as the same variables concurrently affect level of development and democracy. The second reverses the arrow between development and democracy—democracy has the causal primacy as it fosters economic development. Olson (1997) argues that democracies can better secure property rights and contract enforcement than autocracies, which are subject to the problem of succession. The links among democracy, allocation of political power, and economic institutions are widely studied regarding their impact on economic development.

Despite the existence of a lively debate on institutions, what is lacking in the current scholarship is an analysis of institutional change. What accounts for the emergence of good institutions that would foster economic development? Given that institutions are considered “sticky” or persistent, how might the ineffective or dysfunctional institutions in the LDCs be replaced by “good” institutions? What kind of redistributive strategies would resolve existing collective action problems that impair institutional change? What leads to the emergence and spread of informal institutions, particularly social norms?

During the initial wave of market reforms in the 1980s, which were carried out under the auspices of international organizations, institutions were not given much attention. International organizations mostly provided purely policy advice without touching upon institution building. Nor did these organizations take into consideration domestic institutional arrangements and power relations in the countries that were provided with loans and policy advice. But, later, the empirical evidence, particularly the recurring crises, showed that policy change itself was not the panacea for acute problems, and sometimes such change without an appropriate institutional framework aggravated the existing problems. Particularly after the 1997 Asian crisis, the perspectives of these organizations changed considerably, as they came to terms with the understanding that better institutions yielded better outcomes. Hence, a consensus has evolved with respect to the inadequacy of policy change without appropriate institutions.

Since the 1990s, “good governance” has become the buzzword in the international organizations and their development-related advice to LDCs, signifying a dominant belief in not only institutions but “good institutions.” Under the impact of institutional schools that pinpointed the limitations of “getting the prices right,” these international organizations started replacing conditionalities that used to be merely based on policy advice with those related to governance.

Parallel to the institutional resurgence in the 1990s, the UNDP also put particular emphasis on democratic governance and aimed to build local capacity for accelerating development. Having challenged the simplistic definition of development based on income per capita, the UNDP launched a new concept: “human development.” With this goal, since the 1990s the UNDP has been publishing the Human Development Index (HDI), the successor to the Physical Quality of Life Index (PQLI) of the late 1970s. The HDI takes into account life expectancy, knowledge, and education in addition to income per capita. It shows that countries that have similar income per capita levels may differ regarding life expectancy and literacy. Nevertheless, HDI indicators show a high correlation between income per capita and other indicators of “human development,” which makes it an uneasy substitute for the conventional definition of economic development.

The UN’s Millennium Development Goals set rather ambitious targets, of which eradicating poverty is the most pronounced. The UN seeks to consult with other international organizations to assign responsibilities to advanced countries with respect to acute problems, such as removal of trade barriers against LDC exports, abolishing explicit and “disguised” protectionism, and eliminating the debts of the poorest countries. Neither the goals nor the assignments have yet been met.

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