Two-Gap Model

Background

The Two-Gap Model in economics seeks to explain the constraints on the development of less developed countries (LDCs). It posits that economic growth is hampered by two primary gaps: one between domestic savings and the necessary investment for development (the savings-investment gap), and another between export revenues and the import costs required for development (the foreign exchange gap). This model is particularly prominent in the framework of development economics.

Historical Context

The Two-Gap Model emerged in response to challenges faced by LDCs during the mid-20th century. As these countries sought to transition from agrarian to industrial economies, economists identified systematic obstacles impeding sustained economic growth and development. The Two-Gap Model was formalized in the 1960s as part of a broader effort to understand and mitigate these constraints.

Definitions and Concepts

Savings-Investment Gap: The disparity between domestic savings and the investment needed for economic take-off.
Foreign Exchange Gap: The shortfall between export revenues and the import requirements necessary for economic development.

In accordance with national income accounting theory, these gaps are interlinked and not entirely independent of each other.

Major Analytical Frameworks

Classical Economics

Classical economists emphasize the importance of accumulated capital investment for growth. In this context, the savings-investment gap is central, as low savings rates in LDCs naturally would hinder capital accumulation and, consequently, economic growth.

Neoclassical Economics

Neoclassical economics focuses on the role of market mechanisms in addressing the gaps. Solutions typically propose enhancing the efficiency of markets to better mobilize both domestic savings and foreign exchange through trade liberalization and capital flows.

Keynesian Economic

In the Keynesian framework, government intervention is often necessary to fill both gaps. This might include policies that encourage domestic savings or subsidies to foster industrial exports.

Marxian Economics

Marxian theories critique the capitalist mode of production and argue the development challenges in LDCs are rooted in systemic inequalities and exploitation, positioning the Two-Gap Model within the context of global capital structures.

Institutional Economics

Institutional economists focus on the role of governing bodies and their influence on economic development. They consider the Two-Gap Model in relation to institutional capacity, the quality of governance, and policy frameworks that influence both savings and export performance.

Behavioral Economics

Behavioral economics underlines the psychological and social factors behind savings behavior and consumer choices, emphasizing how these factors could affect the savings-investment gap.

Post-Keynesian Economics

This approach stresses the endogenous components of finance and their relation to economic development, advocating for policies tailored to the specificities of each economy to bridge the savings-investment gap effectively.

Austrian Economics

Austrian economists argue for minimal intervention and stress the role of individual savings and entrepreneurship in overcoming economic barriers.

Development Economics

The Two-Gap Model is a fundamental theory in development economics, often forming the basis for examining the financial and trade policies of LDCs and providing groundwork for targeted foreign aid and international financial assistance.

Monetarism

Monetarists may examine the gaps chiefly through monetary policy lenses, stressing stable money supplies to encourage more significant rates of domestic savings and investment while others argue for foreign direct investment strategies.

Comparative Analysis

The Two-Gap Model offers a dual lens for examining the development impediments faced by LDCs. Comparative analyses often focus on how different regions or countries experience these gaps distinctly and how varying policy responses have succeeded or failed in bridging them.

Case Studies

Several case studies illustrate how countries, like South Korea and Taiwan, successfully navigated both gaps through aggressive savings mobilization and export-led growth strategies. In contrast, others, like many sub-Saharan African nations, still face significant challenges.

Suggested Books for Further Studies

“Economic Development” by Michael P. Todaro and Stephen C. Smith
“Development as Freedom” by Amartya Sen
“The End of Poverty: Economic Possibilities for Our Time” by Jeffrey Sachs

Harrod-Domar Model: A growth model emphasizing the role of savings and investment in economic development.
Export-Led Growth: A strategy focusing on expanding exporting activities as a driver for economic development.
Import Substitution Industrialization (ISI): A policy strategy focused on replacing foreign imports with domestic production.