Let me begin this paper with a quote from an article published in the Rhodesian Journal of Economics: “If one assumes an incremental capital- output ratio for Rhodesia of the order of 3 :1 and a desired rate of economic growth of six per cent per annum this would mean a desired rate of net investment of no less than 18 per cent of GDP.”' This statement, which is based on the Harrod-Domar model of growth, reflects all the properties of modern growth theories such as elegance, quantifiability and deterministic solution. Yet, it seems to be a historical fact that countries least concerned with the implementations of modern growth models have done as well if not better for their people as those countries which have embarked upon various planning schemes.
In this paper I will argue that to consider the saving-investment relationship as a major determinant of the rate of growth, and an increase in the supply of investible funds as a major determinant of the increase in the rate of growth is at best misleading and at worst nonsensical. For faster rate of growth of wealth is achieved not merely by increased saving but by more effective institutions for organizing, co-ordinating and directing productive activity

Pejovich, Svetozar

English

IDS OpenDocs

Volume Two, Number Four December, 1968
THE RHODESIAN JOURNAL
°f
ECONOMICS
The Quarterly Journal of the Rhodesian Economics Society
Editorial Board:
A. M. Hawkins (Editor), M. S. Brooks, M. L. Rule, P. J. Stanbridge
and P. Staub.
ARTICLES page
E d u c a tio n a l D ev elo p m en t in  R h o d esia R. C. Bone 5
M ajo r In s titu tio n a l R e q u ire m e n ts  fo r  
S u c c e ssfu l E co n o m ic  D ev elo p m en t S. Pejovich 28
In d u s tr ia l C lassifica tio n s in N a tio n a l A c c o u n tin g E. Osborn 33
The C ase fo r  R o ad  T ra n s p o rt in  R h o d esia P. J. B. Wimbush 38
Review Article 43
M a rx is t T ax o n o m y  C om es to  R h o d esia
Addresses
E m p lo y m e n t P ro b lem s in  R h o d esia A. E. Abrahamson 50
D ev elo p in g  T he T rib al T ru s t L an d s J. J. W rathall 54
Economic Diary 65
MAJOR INSTITUTIONAL REQUIREMENTS 
FOR SUCCESSFUL ECONOMIC DEVELOPMENT*
By SVETOZAR PEJOVICH
I
Let me begin this paper with a quote from an article published in the 
R h o d e sia n  J o u rn a l o f E conom ics:  “If one assum es an increm ental capital- 
output ratio for Rhodesia of the order of 3 :1 and a desired rate  of economic 
growth of six per cent per annum  this would mean a desired ra te  of net 
investm ent of no less than 18 per cent of GDP.”' This statem ent, which is 
based on the Harrod-Domar model of growth, reflects all the properties of 
modern grow th theories such as elegance, quantifiability and determ inistic 
solution. Yet, it seems to be a historical fact th at countries least concerned 
w ith the implementations of modern growth models have done as well if 
not better for their people as those countries which have em barked upon 
various planning schemes.
In this paper I will argue th at to consider the saving-investm ent 
relationship as a m ajor determ inant of the rate  of growth, and an increase 
in the supply of investible funds as a m ajor determ inant of the increase 
in the ra te  of growth is a t best misleading and at w orst nonsensical. For 
faster rate of growth of w ealth is achieved not merely by increased saving 
but by more effective institutions for organizing, co-ordinating and 
directing productive activity.
II
Taking the static analytical concepts of Keynes as their point of 
departure, Harrod, Hicks and others have developed a num ber of dynamic 
grow th models. The common denom inator of all those models is th a t the 
saving-investment relationship is taken as the prim ary endogenous source 
of economic growth. The structure of the economy, th at is technology and 
organizational framework, is assumed either constant or changing a t some 
postulated rate. Hicks, for example, got his model moving by assum ing an 
innovation.2 Yet he analysed the economic process by postulating that 
changes in technology and organization are external to the working of the 
economic system, and thus fall outside the scope of economic analysis. 
In other words, modern grow th theories which have evolved from the basic 
Keynesian model consider increases in the supply of investible funds at 
the expense of current consumption as the m ajor source of larger social 
dividend. Thus, there is nothing wrong, and in fact it is desirable, to 
supplem ent private investm ent by tax-financed governmental expenditures
1. A. M. Hawkins, “The Rhodesian Economy Under Sanctions”, Rhodesian Journal 
of Economics, Vol. 1, No. 1, p. 58.
2. J. Hicks, A Contribution to  the Theory of the Trade Cycle (London: Oxford 
University Press, 1961).
* The author is grateful to the Relm Foundation for research grant during 
which the paper was w ritten.
28
MAJOR DEVELOPMENTS 2 9
whenever private w ealth owners fail to save and invest “enough”. The 
policy of extracting forced saving from the community m ay have the 
counter-effect of a possible fall in the ra te  of saving out of the reduced 
disposable income; it  m ay also result in the use of private savings to 
create goods th a t yield more nonpecuniary income. These considerations 
are somehow missing from m odem  growth models.
Yet, the m ajor reason for failure of Harrod-Domar types of growth 
models is their incompleteness. This incompleteness arises from their 
neglect to recognize th at economic activity involves a double variation:1 
variations in the quantity  of inputs which they recognize, and variations 
in the quality of inputs which they do not. The latter means a technological 
or organizational innovation or, w hat is the same thing, a change in the 
index of significance of inputs relative to output.
It is not too difficult to understand why the act of innovation is 
presumed to fall outside the scope of economic analysis by modern growth 
theorists. Innovation can be neither planned nor predicted in advance. 
Moreover, innovations occur in clusters rather than a t random. Thus, a 
growth model which would consider innovation as a nendogenous variable 
would be, by definition, an indeterm inistic one. The model builder, searching 
for a fashionable determ inistic solution, has no choice, and the economic 
planner in fact finds it in his own self-interest, to assume aw ay such an 
uncontrollable variable as innovation. Baumol, for one, said th a t th e type 
of analysis presented by Schum peter does not appeal to him because he 
failed to build a determ inistic system .2
It is im portant, however, to recognize the m ajor difference between 
the quantitative and qualitative economic change. The former leads to an 
increase in national output v ia  a  sacrifice of current consumption, while 
th e la tter means an increase in the community’s welfare v ia  more efficient 
use of resources. Thus, it is the act of innovation which makes a true 
contribution to  economic development. It follows th a t the m ajor problem 
of economic development is to maximize the flow of innovation. And since 
innovation can be neither planned nor predicted th e major problem of 
economic development boils down to creating the environm ent conducive 
for carrying out innovating activities.
Ill
The m ajor requirem ents for creating the environm ent conducive for 
carrying out innovating activities are: freedom to innovate, the availability 
of economic power to innovate and a system  of sufficient incentives.3 The 
question is w hat are some m ost im portant institutions which th e  community 
should endeavour to strengthen in order to satisfy these three major 
requirem ents.
1. To the best of my knowledge Schumpeter was the first economist to explicitly 
incorporate both variations into his theory of development. See J. Schumpeter, 
The Theory of Economic Development (Cambridge: Harvard University Press, 
1959).
2. W. Baumol, Economic Dynamics (New York, Macmillan Co., 1951), p. 35.
3. See S. Pejovich, The M arket-Planned Economy of Yugoslavia (Minneapolis: 
University of Minnesota Press, 1966), Chapter V.
30 RHODESIAN JOURNAL OF ECONOMICS
Freedom to innovate is defined as the freedom to change the allocation 
of resources according to the innovator’s vision. The act of innovation 
means an introduction of novelty into the flow of economic life. Thus, it 
presupposes a  contractual agreem ent which gives th e innovator command 
over some resources. It follows th a t the conditions governing the freedom 
of contractual agreem ents determ ine the freedom to innovate.
Consider an agreem ent between tw o parties to  exchange goods and 
services (including labour, of course). It m ust be presum ed th a t a t  least 
one p arty  of the contract expects to  be b etter off, to  reach a higher 
indifference curve so to  speak, after th e  contract is executed th an  before. 
Otherwise one or both of them  would not accept the deal. If a  voluntary 
contract w ere expected to  improve th e economic w elfare of both parties to  
the contract, or of one of them  leaving the other as well off as before, an 
increase in th e extent of contractual activities would lead to  an 
improvement in the com m unity’s welfare.
W henever w e enter into a voluntary exchange (w hen we sell our labour 
for wages or buy a pair of shoes in a store) we exchange some property 
rights. In fact, every commercial contract m eans an exchange of some 
bundle of private property rights, and thus it presupposes the existence 
of those rights. It follows th a t the greater th e scope of private property 
rights the more contracts could be reasonably expected.
The basic elem ents of private property rights are e x c lu s iv ity  of right 
of use and v o lu n ta ry  tra n s fe ra b ili ty  of th a t right. No person can transfer 
to another person m ore rights to  a thing than he himself possesses. Thus 
any reduction in the extent of private property rights m ust be reflected in 
a reduction of contractual activity. Let me m ention three examples.
The economist would usually say th a t a  minimum wage law  elim inates 
some people from th e labour force. He could also say, and I think it would 
be a  better w ay of saying it, th a t a  minimum wage law attenuates our 
property rights over our own labour by forbidding us to  transfer it to  th e 
employer below a  certain price. Consequently, it  prevents some people 
from  entering into contractual agreem ents w ith their prospective employers, 
i.e. it  prevents them  from  seeking the m ost preferred position. My second 
example should be fam iliar to a university professor. Assum e th a t tw o 
departm ents have different indifference ratios between secretaries and 
space. They could both  reach a higher indifference curve v ia  exchange. 
Yet, they are, as a rule, unable to enter into a  m utually advantageous 
contract because they do not have private property rights over the funds 
allocated for secretarial help and space. Finally, unwillingness or expecta­
tions about unwillingness of th e state  to strengthen private property rights 
would m ake people fearful of theft of the w ealth they accum ulate and 
force them  into a type of behaviour—accumulation of gold, diamonds, etc. 
—which reduces the scope of contractual activity.
These three examples indicate th a t the attenuation of private property 
rights, the absence of private property rights and expectations about the 
weakening of private property rights reduce the extent of contractual 
agreem ents in a community, thus preventing its members from  reaching 
the m ost preferred position. It follows th a t the freedom to innovate, th a t
MAJOR DEVELOPMENTS 31
is the possibility of acquiring and using resources in accordance w ith the 
innovator’s vision depend on th e scope of private property rights.
The availability of economic power is the second factor influencing 
economic development. The freedom of the innovator to  enter into 
contractual agreem ents which provide him w ith  command over scarce 
resources and his freedom to  use them  in accordance w ith his vision are 
futile w ithout the economic power w hereby those resources could be 
acquired.
For Schumpeter, who based his whole theory of development on the 
concept of economic power, this power m eant a source of energy within 
the economic system  which disrupts any equilibrium th a t m ight be attained 
and provide us w ith a purely economic theory of economic change. It 
could be argued th a t the economic power of Schum peter is m erely the old 
concept of purchasing power. Yet, the qualitative difference betw een the 
tw o concepts exists. Physically, it could be the same sum of money. In 
Schum peter’s scheme, however, it is n o t a  medium of exchange which 
equalizes m arginal costs and utilities and moves the system  tow ards an 
equilibrium. It is th e  source of energy which disrupts th e equilibrium 
relationships and becomes the engine of the qualitative economic change; 
the act of innovation being an injection of novelty into the flow of economic 
life it  aims a t  the satisfaction of w ants whose marginal utilities are not 
known and can be only anticipated.
I t  follows th a t the more readily is the economic power available to  the 
innovator the easier it would be for him to  implement his ideas. The well 
developed banking system  willing and able to extend credit appears to 
be a m ust.
The third requirem ent of economic development is the system  of 
incentives. The act of innovation being a non-routine action entails a 
relatively high degree of risk  and uncertainty about its outcome. And why 
should one try  to  implement his ideas and break the established equilibrium 
relationships unless he is given sufficient incentives for the risk he takes? 
And to be given sufficient incentives it m ust m ean th a t the innovator m ust 
be assured of his right to appropriate the gains from innovation. Once again 
it suggests the im portance of private property rights for successful 
economic development. While our modern theories of growth seems to 
neglect this point the economists in Eastern Europe, thanks to  their 
experience w ith planning I guess, are becoming fully aw are of it. Recently, 
a  leading Yugoslav economist wrote: “If one w ants to  expand and improve 
entrepreneurial activity, one cannot avoid the flow of entrepreneurial 
product of entrepreneurs, whoever they m ay be . . . one cannot negate 
the economic necessity th a t entrepreneurs be proprietors of their 
products . . . entrepreneurial activity . . .  is merely a special kind of work 
which it  is necessary to supply in adequate quantities and quality of 
production . . . entrepreneurial incurves can never be regarded as state 
or society incurves. . . .  I would not be surprised, therefore, if somewhere
3 2 RHODESIAN JOURNAL OF ECONOMICS
in the future this will find its expression in giving enterprises property 
rights in their means of production.”1
IV
W ithout denying the im portance of grow th instrum ents such as fiscal 
and m onetary policies, and propensities to save and investm ent, this paper 
has attem pted to  explore the contribution which some institutions can 
m ake to  creating the environm ent conducive for innovating activities. The 
conclusions reached are twofold: (1 ) the institutions of private property 
and m odem  banking system  are of utm ost im portance for successful 
economic development; and (2 ) m odem  grow th models fail in practice 
because their im plementation leads to the attenuation of private property 
rights and thus result in a reduction in the scope of contractual activity.
1. A. Bajt, “Property in Capital and in the Means of Production in Socialist 
Economies”, Journal of Law and Economics, April, 1968, pp. 1-5.
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Major Institutional Requirements for Successful Economic Development

Let me begin this paper with a quote from an article published in the Rhodesian Journal of Economics: â€œIf one assumes an incremental capital- output ratio for Rhodesia of the order of 3 :1 and a desired rate of economic growth of six per cent per annum this would mean a desired rate of net investment of no less than 18 per cent of GDP.â€' This statement, which is based on the Harrod-Domar model of growth, reflects all the properties of modern growth theories such as elegance, quantifiability and deterministic solution. Yet, it seems to be a historical fact that countries least concerned with the implementations of modern growth models have done as well if not better for their people as those countries which have embarked upon various planning schemes.

In this paper I will argue that to consider the saving-investment relationship as a major determinant of the rate of growth, and an increase in the supply of investible funds as a major determinant of the increase in the rate of growth is at best misleading and at worst nonsensical. For faster rate of growth of wealth is achieved not merely by increased saving but by more effective institutions for organizing, co-ordinating and directing productive activity

Pejovich,  Svetozar

National Research Database of Zimbabwe

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Major Institutional Requirements for Successful Economic Development

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