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Economics of Development Chapter 3. Characteristics of Underdevelopment and Structural Change Dominance of agriculture and petty services Low level of capital accumulation Rapid population growth Exports dominated by primary commodities Curse of na...

Economics of Development Chapter 3. Characteristics of Underdevelopment and Structural Change Dominance of agriculture and petty services Low level of capital accumulation Rapid population growth Exports dominated by primary commodities Curse of natural resources Weak institutional structures Other dimensions of development gap Inequality: vertical and horizontal Growth and distribution: Poverty-weighted growth rates Stages of development and structural change Rostow’s stages of growth Industrialisation and growth 1 Kaldor’s growth laws  Economics of Development Dominance of Agriculture and Petty Services Over half of population in developing countries live and work in rural, agricultural sector as subsistence or tenant farmers, sharecroppers or landless labourers (see Table 3.1) Labour productivity very low: less than $500 a year or less than $1.90 a day Disguised unemployment due to diminishing returns to labour Demand for most agricultural goods income inelastic (Engel’s Law) Industry has superior production and demand characteristics Industry has much higher labour productivity 2  Economics of Development Table 3.1 Distribution of employment, by sector (percentage) Region Agriculture Industry Services (%) (%) (%) Asia and the Pacific 53.7 17.9 28.4 Eastern Asia 34.8 23.8 41.4 Low income Latin America and the Caribbean 43.3 10.8 45.9 South-Eastern Asia and the Pacific 50.1 16.8 33.1 Southern Asia 67.5 14.6 17.9 Sub-Saharan Africa 71.2 7.1 21.7 Asia and the Pacific 43.8 21.8 34.4 Lower-middle income Latin America and the Caribbean 28.7 18.2 53.1 South-Eastern Asia and the Pacific 38.1 19.0 42.9 Southern Asia 46.0 23.0 31.0 Sub-Saharan Africa 49.0 10.9 40.2 Upper-middle income Asia and the Pacific 24.5 25.7 49.8 Eastern Asia 24.0 25.7 50.3 Latin America and the Caribbean 15.2 21.2 63.6 South-Eastern Asia and the Pacific 34.3 22.0 43.7 Southern Asia 19.8 32.0 48.2 Sub-Saharan Africa 18.8 16.1 65.1 Asia and the Pacific 4.0 25.5 70.5 High income Eastern Asia 4.2 26.2 69.6 Latin America and the Caribbean 4.9 22.5 72.7 3 South-Eastern Asia and the Pacific 2.9 21.2 75.9 Source: ILO, 2015, Table R4  Economics of Development Low Level of Capital Accumulation Economic development is a generalised process of capital accumulation Saving and investment low, so capital per head low Sustained growth of per capita income (PCY) requires a ratio of savings-investment to GDP in excess of 10% (Rostow, Lewis) This ratio comes from Harrod growth formula: g = s/c where s is the saving ratio and c is the incremental capital-output ratio. If population growth is 2%, g must exceed 2% for PCY to rise. If c =3, s = 12% for sustained growth of PCY Net savings-investment ratio exceeds 10% in most poor countries. In China it exceeds 30%, explaining China’s fast growth 4  Economics of Development Rapid Population Growth More rapid in poor countries (>2% p.a.) than rich (0.5%), posing many problems Growth slowing recently due to declining birth rate, but age distribution of population still very young Rapid population growth another vicious circle: poverty →more children →reduces income per head→ poverty Population puts pressure on food supplies; causes overcrowding and congestion; causes unemployment; strains government resources; impairs environment (see Chapter 12) Optimum population difficult to define; depends on definition of ‘optimum’ 5  Economics of Development Exports Dominated by Primary Commodities: Curse of Natural Resources This dominance has three main disadvantages: Long run deterioration in terms of trade (see Chapter 15) Income elasticity of demand < 1 (Engel’s Law), but income elasticity of manufactured imports > 1 causing balance of payments problems Prices more volatile than manufactures: macro-instability Countries dependent on primary products grow slower (curse of natural resources): Terms of trade and balance of payments problems Over-valued exchange rate (Dutch disease) Rent seeking and corruption by bureaucrats and politicians 6  Economics of Development Weak Institutional Structures Weak institutions one of fundamental causes of underdevelopment e.g. without rule of law and property rights, entrepreneurs will not invest Quality of government, and constraints on power and corruption, also important Poor governance and weak institutions lead to civil war and failed States Weak institutions (e.g. in Africa) have historical origins because colonisers came to extract resources not to settle (Chapter 8) 7  Economics of Development Other Dimensions of Development Gap Unemployment and underemployment is high in poor countries –on the land and in the cities Providing jobs for a growing labour force is a major challenge in developing countries ILO reckons one-third of labour force is either openly unemployed or disguisedly unemployed in sense that labour wants to work but can’t find it Disguised unemployment on the land takes form of low number of hours worked Disguised unemployment in the cities is concentrated in petty services sector where productivity is below the poverty line of $1.90 a day Unemployment in the cities fuelled by rural-urban migration process (see Chapter 5) 8  Economics of Development Inequality: Vertical and Horizontal Distribution of income, wealth, power much more unequal in poor countries Two types of inequality: vertical and horizontal Vertical inequality is distribution of income and wealth across households measured by Gini ratio (Chapter 2) Vertical inequality first increases with development, then decreases (Kuznets curve) Horizontal inequality is differential treatment of people based on race, religion, language, class, gender, etc. Horizontal inequality major cause of conflict, damaging development 9  Economics of Development Growth and Distribution: Poverty-Weighted Growth Rates Debate about whether growth benefits poor as much as rich Inequality not good for growth because associated with lack of equal opportunities; bad governance; weak property rights Country’s measured growth rate ignores how growth is distributed Better measure of growth of welfare is to weight income gains of poor higher than for rich to get a poverty-weighted growth rate 10  Economics of Development Stages of Development and Structural Change Only three countries in world have become rich based on agriculture alone –Australia, New Zealand and Canada Most countries have gone through ‘stages’ called by Rostow: traditional; transitional; take-off; maturity; and high mass-consumption Stages correspond to resource shifts from primary (agriculture) to secondary (manufacturing) to tertiary (services) production –the Fisher- Clark thesis Most fast growing countries are ‘newly industrialising countries’ (NICs) in take-off stage with shift to manufacturing With development comes diversification of activity from natural into man- made areas of comparative advantage (based on skills and technology). Then countries specialise again. 11  Economics of Development Industrialisation and Growth Strong association across countries between manufacturing growth and GDP growth because: – Static and dynamic returns to scale in manufacturing (Verdoorn’s Law) – Manufacturing absorbs labour from diminishing returns activities raising productivity in non-manufacturing Hypothesis of manufacturing as ‘engine of growth’ known as Kaldor’s growth laws. Tested extensively across countries; across regions within countries, and time series, and generally supported Policy issue is how to speed up resource shift into manufacturing industry: market versus state intervention, using protection, subsidies, financial incentives; directed credit; etc. 12  Economics of Development Kaldor’s Growth Laws 1st Law: strong positive correlation between the growth of manufacturing output (gm) and the growth of GDP (gGDP) gGDP = f1 (gm) f’1 > 0 2nd Law: strong positive correlation between the growth of manufacturing output (gm) and the growth of productivity in manufacturing (pm) due to static and dynamic returns to scale (also called Verdoorn’s Law) pm = f2 (gm) f’2 > 0 3rd Law: strong positive relationship between the growth of manufacturing output (gm) and the growth of productivity outside of manufacturing (pnm) because as resources shift from agriculture to industry, the productivity in agriculture rises pnm = f3 (gm) f’3 > 0 13  Economics of Development Learning Objectives You should now know: Characteristics shared by poor Meaning of vertical and horizontal countries: concentration of inequality resources in low productivity Poverty-weighted growth rates agriculture; low saving and Rostow’s stages of growth investment ratios; rapid population growth, and exports dominated by Fisher-Clark thesis of structural primary commodities change Why unemployment and Role of industry in economic underemployment are high development ‘Curse’ of natural resources Kaldor’s growth laws Role of institutions in development 14  Economics of Development Summary Poor countries share many common characteristics: dominance of low productivity agriculture; low saving-investment ratio; rapid population growth; curse of natural resources Weak institutional structures in poor countries Unemployment and underemployment high because of limit to employment on land and not enough capital accumulation to generate alternative jobs Income distribution very unequal in poor societies; discrimination rife Many horizontal inequities Countries pass through stages of development, as outlined by Rostow Sectoral composition of output shifts from primary production to manufacturing to services in process of development: Fisher-Clark thesis Growth of manufacturing has been engine of growth historically and is today: Kaldor’s growth laws 15  Economics of Development Websites Labour market statistics International Labour Organization http://laborsta.ilo.org Income distribution University of Texas, Inequality Project http://utip.lbj.utexas.edu/ WIDER https://www.wider.unu.edu/project/wiid-%E2%80%93-world-income-inequality- database Luxemburg Income Study Center www.gc.cuny.edu/liscenter 16