Two-gap theory, Chenery and Strout, 1966 - Era of modernisation theory

The Two-gap theory was proposed by economists Theodore W. Schultz and Hollis B. Chenery and their associate Moses Abramovitz in the 1960s and has since been developed by economists, such as Alan H. Strout. This theory claims that developing countries suffer from two major gaps or shortages: (1) the foreign exchange gap and (2) the domestic resource gap. The former refers to the fact that many developing countries do not have enough currency on hand to finance development and must receive it from abroad. The latter refers to the gap between the need for domestic investment and the availability of factors of production – like labor, capital, and even land – necessary for effective production. The two-gap theory is an important part of the modernisation theory, which suggests that less-developed countries can improve their economic standing by emulating the economic strategies of more economically advanced nations. This theory works on the premise that if developing countries can fill their gaps, they should be able to reach a certain level of economic progress. This theory focuses on the shift of economic resources and encourages a movement away from traditional industry and agriculture to industries and production that use modern technologies. Trade and government policies also play a role in this theory as countries can invest in improving infrastructure and establishing trade agreements that limit competition in order to help grow the economy.