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Abstract: Mrydal’s theory of circular and cumulative causation challenges the underlying assumptions of the neo-classical analysis; it allows for the secondary effects of an exogenous shock which create further movements away from equilibrium. Growth generates its own momentum through mechanisms such as the scale economies and technological progress created by the increased output and population. Growth of the growing region may also be at the expense of backward regions which experience the migration of capital and labour. Although the beneficial "trickle down effects" on the backward regions compensate for these negative backwash effects, the latter generally outweigh the former; whilst growing regions are caught in virtuous circles of growth, lagging regions find themselves in vicious circles of poverty. Theories of dependence and risk aversion in developing countries adds to the perpetuation of poverty.

According to neo-classical analysis, mechanisms working both nationally and internationally will always work towards market equilibrium. Striking examples of this neo-classical static equilibrium "story" are the process by which labour moves from areas of high unemployment towards areas of low unemployment, and the theory of factor price equalisation across countries. There are therefore underlying influences, i.e. trade, population growth and the movement of capital and labour, which act towards convergence within the world economy and between regions within a nation. The underlying assumptions of this theory are the independence of supply and demand, the homogeneity of factors of production, and increasing returns in all industries. These assumptions underpinning the theory, as with most neo-classical analysis, are not entirely consistent with the real world; static equilibrium theory fails to explain the persistence of underdeveloped regions and differences in development between nations unexplained by initial factor endowments. Indeed, Hirschman highlights the natural tendency for the "spatial concentration of economic growth", both nationally and internationally. Myrdal’s theory addresses the failure of static equilibrium theory by replacing it with the process of circular and cumulative causation which accounts for the continued differences in a range of economic development indicators between the "centre" and the "periphery", i.e. geographical dualism. The natural tendency for concentrated growth is sustained by mechanisms working towards disequilibrium. Once a country or region attains an advantage, the process of circular and cumulative causation leads to a virtuous circle of growth, whereas the same process leads vicious circle of poverty for lagging regions. Mechanisms such as the tendency for capital and labour to move in the same direction, (towards the highest return in a free market), and the increased competitive advantage the growing region attains from economies of scale lead to process of circular and cumulative growth of prosperous areas. There are also internal and external mechanisms that work at the international level towards perpetuating underdevelopment of countries.

Rostow’s export-growth model may be taken as an example of how vicious circles perpetuate underdevelopment. Firstly growth is a function of exports. In turn, export earnings are a function of the difference between domestic and foreign prices and the growth of world income. Domestic prices are determined by the change in wages minus the rate of change of productivity. Finally, the rate of change of productivity is a function of growth, which returns us to the original equation; in order to improve growth, productivity must be improved, which is itself a function of growth. This reflects the circular notion of underdevelopment. The only way to break free from this trap is through an exogenous shock, but geographical dualism then highlights the cumulative effects such a shock may have. Rather than eventually converging towards equilibrium growth rates, growing regions tend to attract capital and labour at the expense of the relatively lagging regions.

Economic disparities between two previously identical regions within a nation (A and B) emanating from such an exogenous shock may lead to a situation of disequilibrium in the development process between regions. According to static equilibrium analysis, a situation of equilibrium would return: for example, factor mobility would equalise the wage and profit rates between regions as labour and capital will always flow from regions in which they are abundant to regions in which they are scarce. Contrary to this process of equalisation, Myrdal considered a type of multiplier-accelerator mechanism whereby supply and demand are no longer considered as independent, but interact to produce cumulative movements away from the original equilibrium, i.e. the cumulative expansion of the prosperous region (B) at the expense of backward region (A). "There is no tendency towards automatic self-stabilisation...(and) the system is constantly on the move away from such a situation" (Myrdal). For example the initial labour migration towards B reduces human capital and depresses demand for goods, services and factors of production in area A; the same movements will stimulate business and the demand for products in B, further increasing the demand for labour as well as attracting capital to B. These "backwash effects" perpetuate or even worsen development differentials between regions.

In addition, returns to scale play an important role in maintaining or even widening the development gap. Given a free capital market, capital will move towards the region in which the returns are highest. This will be the area in which demand is strong and the flow of capital will therefore follow labour into the prosperous region. The competitive advantage of the growing region is thus increased with subsequent increases in real income levels. Moreover, the migration of labour will have additional consequences for the growing region by creating economies of scale in infrastructure, allowing for increased productivity and therefore growth over and above that experienced by the lagging regions. Given the outflow of human capital, the relative productivity of the lagging regions will be further reduced, leading to an increased divergence in growth rates. Myrdal’s theory therefore treats the secondary effects on the demand for capital and labour, i.e. the increased concentration of factors in the growing region. China is a striking example of the dualistic nature of developing countries, with Special Economic Zone export regions, such as Shenzhen, growing much more rapidly than the surrounding regions and therefore attracting both labour and capital. These backwash effects may be countered by the beneficial spread or trickle down effects - the favourable effects on the backward regions of growth in the expanding regions. These effects describe the technology and knowledge spillover effects and the increased demand for goods from the backward region from the increased real income of the growing area. Myrdal, however, considers these effects to be weak and outweighed by the stronger backwash effects.

These regional imbalances may be addressed by governments if there is a political desire for greater equality, but this process also occurs at the international level. Centre-periphery models describe the dualistic nature of the world economy. At the international level, labour migration from peripheral countries with a surplus of labour is restricted, and labour is not considered to be homogeneous. Indeed, any migration that does occur is very selective and robs underdeveloped nations of valuable human capital. The International flow of capital also contradicts static equilibrium theory, with rapidly expanding economies such as China (the biggest recipient of foreign investment) attracting by far the greater share of foreign investment. Capital tends to be concentrated around a core of countries: developed countries receive 60% of the total of direct foreign investment (OECD). Between 1990 and 1995, direct investment in Africa fell by 2.4% to $2.2 billion, or less than the entire amount invested in Chile (CEPII).

Historical factors also play an important role in perpetuating the process of circular and cumulative causation. Theories of dependence highlight the continued effects of colonialism and the so-called neo-colonialism of international capitalism. Developing countries tend to be involved in the primary sector, characterised by a low income elasticity of demand; and multinationals continue the tradition of exploitation, introducing inappropriate consumption and production techniques to the host country. Moreover, low terms of trade associated with the export of primary product limits the developing countries’ ability to purchase foreign goods with their domestic currency, limiting the possibilities for importing the capital goods necessary for development.

Forces within poor countries also tend to perpetuate poverty and therefore underdevelopment of certain less developed nations, what Galbraith labels the "accommodation of poverty". People on the margin of existence cannot afford to take the risks inherent in changing production techniques; they prefer to undertake activities with lower mean outcomes with a low variance, rather than higher mean outcomes with a higher variance. The status quo is therefore maintained. The tendency for large family sizes for security also works to keep underdeveloped nations trapped in vicious circles of poverty, what Malthus described as a low-level equilibrium trap.

In sum, there is a natural tendency towards the development of certain regions at the expense of other, less developed, ones; initial factor endowments and rapid expansion these have generated have lead to further advantages such as economies of scale and technological change. Once a country or region attains an advantage, it tends to sustain that advantage: the process of circular and cumulative causation leads to virtuous circles of growth at the expense of regions left behind, caught in vicious circles. This outcome is contrary to static equilibrium analysis which predicts a return to equilibrium growth rates between regions and countries. The main contrast to this analysis is the way in which factors of production migrate. This may be explained by the restrictions to migration of both capital and labour and the heterogeneity of factors. The unrealistic assumption of no interdependencies between supply and demand also accounts for backwash effects on the depressed region. Although Myrdal’s alternative analysis allows for positive trickledown or spread effects on the depressed regions, this is, in general, outweighed by the negative backwash effects. At the international level, further mechanisms, such as risk aversion and theories of dependency, work to perpetuate poverty.

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