Indivisibilities and External Economies: by Rosenstein Rodan

Rosenstein Rodan has given three types of Indivisibilities and external economies:

1. Indivisibility in the production function, particularly the indivisibility of the supply of social overhead capital. It is lumpiness of capital.

2. Indivisibility of demand for complementarity of demand.

3. Indivisibility in the supply of savings.

1. Indivisibilities in the Production Function:

Rosenstein-Rodan argued that indivisibilities of factors of production, outputs or processes result into increasing returns or diminishing costs. Rodan is of the firm view that increasing returns led to fall in capital output ratio (K/Y) in U.S.A. But Rodan considers social overhead capital as the significant example of indivisibility. This would lead to external economies on the supply side.

The social overhead capital including basic industries like transport and communication, power, water supply, sewerage etc., are productive indirectly and these have long maturity period. These cannot be imported. But these services can be provided only if there is ‘sizeable initial lump’ of investment. For some time, in these investments, there would be excess capacity. So they must precede quick yielding directly productive activities (DPA).

According to Rodan, social overhead capital has four indivisibilities:

(i) It is irreversible in time and hence, must precede other directly productive activities (DPA)

(ii) It has a minimum durability, which makes it very lumpy.

(iii) It has long maturity period.

(iv) It has an irreducible minimum industry mix of different types of public utilities.

These indivisibilities of supply of social overhead capital act as an obstacle in the path of economic development of underdeveloped countries. Hence, high investment in social overhead capital is necessary condition to pave the way for quick yielding directly productive activities.

2. Indivisibility of Demand:

In the underdeveloped countries, there are market imperfections which act as deterrent in the way of private investment. As a result, the private investment becomes risky and hazardous. Investment in complementary industries can solve this problem. According to Rodan, “Unless there is assurance that necessary complementary investments will occur, any single investment project may be considered risky to be undertaken at all. But a large investment programme undertaken as a unit may yield substantial increase in national income”.

The indivisibility of demand is also known as complementary of demand. It needs to set up interdependent industries in the developing countries. The individual investment projects have high risks because of uncertainties in selling their products. Investment decisions are interdependent. Rodan explains with the example of shoe industry. In a closed economy, suppose 100 disguised unemployed workers are employed in a shoe factory whose wages give them additional purchasing power. If these labourers spend their entire income on shoes, the shoe market will have a regular demand and hence it will succeed.

In reality the workers of shoe factory will not like to spend their additional income on shoes as human wants differ. Similarly the people outside the factory will not purchase additional shoes when they are poor and are not even in a position to meet their basic needs. Thus in the absence of adequate market, the new factory will be abandoned.

In another way, if bulk of labourers are employed in variety of consumer goods industries, in that case the new producers would be each other’s customers and hence create market for their goods. The complementarity of demand overcomes risks of finding a market and induces the investors to invest. The indivisibility of demand, thus, solves the problem of low investment and small size of the market in underdeveloped countries by the way of high minimum quantum of investment in interdependent industries.

3. Indivisibility in the Supply of Savings:

Third indivisibility is a high income-elasticity of savings. A high minimum size of investment needs high level of savings. But in underdeveloped countries, which are in the grip of vicious circle of poverty cannot afford to save more. Low savings would lead to low level of investment due to which there is low capital formation.

In underdeveloped countries, the only solution is to make all out efforts to increase investment. In order to solve this problem, it is urgent that when income increases due to an increase in investment, the marginal rate of savings should be greater than the average rate of savings. But no country experiences marginal rate of savings more than the previous average rate of savings.