Economic Development Notes PDF

ECONOMIC DEVELOPM ENT REFERENCE 1. Economic Development TWELFTH EDITION, by: Michael P. Todaro and Stephen C. Smith LIST OF TOPIC 1. INTRO: ECONOMIC DEVELOPMENT ON GLOBAL PERSPECTIVE 2. COMPARATIVE ECONOMIC DEVELOPMENT 3. CLASSICAL THEORIES OF ECONOMIC GROWTH AND DEVELOPMENT 4. CONTEMPORARY MODELS OF DEVELOPMENT AND UNDERDEVELOPMENT 5. POVERTY, INEQUALITY, AND DEVELOPMENT 6. POPULATION GROWTH AND ECONOMIC DEVELOPMENT 7. URBANIZATION & RURAL URBAN MIGRATION 8. HUMAN CAPITAL: EDUCATION AND HEALTH IN ECONOMIC DEVELOPMENT 9. AGRICULTURAL TRANSFORMATION 10. DEVELOPMENT POLICY MAKING AND THE ROLES OF MARKET, STATE AND CIVIL SOCIETY 11. ECONOMIC GROWTH MODEL 12. INTERNATIONAL TRADE THEORY AND DEVELOPMENT STRATEGY 13. BALANCE OF PAYMENT, DEBT, FINANCIAL CRISIS, AND STABILIZATION POLICIES 14. FOREIGN FINANCE, INVESTMENT, AID, AND CONFLICT & CONTROVERSIES AND OPPORTUNITIES 15. FINANCE AND FISCAL POLICY DEVELOPMENT CHAPTER 1 INTRO: ECONOMIC DEVELOPMENT ON GLOBAL PERSPECTIVE What Do We Mean By Development development may mean different things to different people so it is important that we have some working definition or meaning. Without that we would be unable to determine which country was actually developing and which was not. Traditional Economic Measures FEATURES :  Traditionally development was generally seen as an economic phenomenon. Development meant achieving sustained rates of growth in per capita income. Traditional approach used to measure overall economic well-being of a population. rapid industrialization and availability of goods and services to the average citizen for consumption and investment was its prime concerns. It implies the planned change of the structure of production and employment so that agriculture’ share of both declines and that of the manufacturing and service industries increases. Traditional Economic Measures LIMITATION The experience of the 1950s to early 1970s signaled that something was wrong with this narrow approach of development For example many developing countries reached their economic growth targets but the levels of living of the masses remained unchanged. Under this approach, poverty, discrimination, unemployment and income distribution which are major challenge before developing countries, could not be addressed. The New Economic View of Development FEATURE During the 1970s, economic development redefined in terms of the reduction or elimination of poverty, inequality, and unemployment within the context of a growing economy. “Redistribution from growth” was its common slogan. The New Economic View of Development Development must therefore be understood as a multidimensional process- involving major changes in social structures, popular attitudes, and national institutions, as well as the acceleration of economic growth, the reduction of inequality, and the eradication of poverty. The New Economic View of Development Development represent the whole range of change by which an entire social system tuned to the diverse basic needs and aspirations of individuals and social groups within that system, moves away from a condition of life widely. Amartya Sen’s “Capability” Approach Amartya Sen, the 1998 Nobel laureate in economics, argues that the “capability to function” is what really matters for status as a poor or non poor person. Sen argues that poverty cannot be properly measured by income or even by utility as conventionally understood; what matters fundamentally is not the things a person has—or the feelings these provide—but what a person is, or can be, and does, or can do. What matters for well-being is not just the characteristics of commodities consumed, as in the utility approach, but what use the consumer can and does make of commodities. Amartya Sen’s “Capability” Approach In the Capability Approach 'poverty' is understood as deprivation in the capability to live a good life and 'development' is understood as expansion of capability.  The Capability Approach focuses directly on the quality of life that individuals are actually able to achieve. This quality of life is analyzed in terms of the concepts of 'functioning's' and 'capability'. Functioning – what people do or can do with the commodities of given characteristics that they come to possess or control. Sen goes on to note that functioning depends also on (1) “social conventions in force in the society in which the person lives, (2) the position of the person in the family and in the society, (3) the presence or absence of festivities such as marriages, seasonal festivals and other occasions such as funerals, (4) the physical distance. In other words Functioning are set of beings and doings. examples of beings-being educated, illiterate, being happy, being depressed, being active in politics , being part of a social work, being part of a criminal work, being well behaved, being well nourished, being under nourished. Examples of doing-Examples of doings -Travelling, Caring for a child, Voting in a election, Taking part in a debate, Taking drugs, Killing animals, Eating animals, Donating Money to charity Capabilities are a person's real freedoms or opportunities to achieve functioning's. Thus, while travelling is a functioning, the real opportunity to travel is the corresponding capability. Amartya Sen has argued that measuring the achieved combination of functioning's of an individual is not always enough to assess well-being. Well-being should include an individual’s “freedom to achieve.” This freedom is represented by an individual’s capability. Freedom of choice, or control of one’s own life, is itself a central aspect of most understandings of well-being. A functioning is a valued “being or doing. The need for capability in the assessment of an individual’s well-being is based on the importance of choice and opportunity. An individual’s well-being can be improved by having more choices. For example, someone who can choose between multiple careers is better off than someone who is limited to one career only, even if both individuals prefer the same career. Development and Happiness happiness is part of human well-being, and greater happiness may in itself expand an individual’s capability to function. In recent years, economists have explored the empirical relationship between satisfaction/happiness and income. One of the findings is that the average level of happiness or satisfaction increases with a country’s average income. Richard Layard identifies 07 factors that surveys show affect average national happiness 1. family relationships, 2.financial situation 3. work, 4.community and friends 5. health 6. personal freedom, and 7.personal values Three Core Values of Development to define what we mean when we talk about development as the sustained up gradation of an entire society and social system toward a “better” or “more human e” life at least three basic components or core values serve as a conceptual basis and practical guideline for understanding the inner meaning of development. These core values—sustenance, self- esteem, and freedom—represent common goals sought by all individuals and societies. Sustenance : The Ability to Meet Basic Needs. All people have certain basic needs without which life would be impossible. These life-sustaining basic human needs include food, shelter, health, and protection. When any of these is absent or in critically short supply, a condition of “absolute under development”exists. Self-Esteem: To Be a Person A second universal component of the good life is self-esteem—a sense of worth and self-respect, of not being used as a tool by others for their own ends. Freedom from Servitude: To Be Able to Choose Freedom here is to be understood in the sense of emancipation from social servitude to nature, other people, misery, oppressive institutions, and dogmatic beliefs, especially that poverty is predestination. Freedom involves an expanded range of choices for societies and their members. Amartya Sen writes of “development as freedom,. The concept of human freedom also encompasses various components of political freedom, including personal security, the rule of law, freedom of expression, political participation, and equality of opportunity The Central Role of Women: development scholars generally view women as playing the central role in the development drama. Globally, women tend to be poorer than men. Children need better health and education, and studies from around the developing world confirm that mothers tend to spend a significantly higher fraction of income under their control for the benefit of their children than fathers do. To make the biggest impact on development, then, a society must empower and invest in its women The Three Objectives of Development We may conclude that development is both a physical reality and a state of mind in which society has, through social, economic, institutional processes, secured the means for obtaining a better life. Whatever the specific components of this better life, development in all societies must have at least the following three objectives: 1. To increase the availability and widen the distribution of basic life-sustaining goods such as food, shelter, health, and protection, 2.To raise levels of living, including, in addition to higher incomes, the provision of more jobs, better education, and greater attention to cultural and human values, all of which will serve not only to enhance material wellbeing but also to generate greater individual and national self-esteem, 3. To expand the range of economic and social choices available to individuals and nations by freeing them from servitude and dependence, not only in relation to other people and nation-states, but also to the forces of ignorance and human misery Conclusion -Thus it is clear that Development is the process of improving the quality of all human lives and capabilities by raising people’s levels of living, self- esteem and freedom. The Future of the Millennium Development Goals Millennium Development Goals (MDGs) A set of eight goals adopted by the United Nations in 2000.The goals are assigned specific targets to be achieved by 2015. to eradicate extreme poverty and hunger; achieve universal primary education; promote gender equality and empower women; reduce child mortality; improve maternal health; combat HIV/AIDS, malaria, and other diseases; ensure environmental sustainability; and develop a global partnership for development. Committing themselves to making substantial progress toward the eradication of poverty and achieving other human development goals by 2015. The MDGs are the strongest statement yet of the international commitment to ending global poverty. They acknowledge the multidimensional nature of development and poverty alleviation; an end to poverty requires more than just increasing incomes of the poor Appropriately, the first MDG addresses the problem of extreme poverty and hunger. The two targets for this goal are more modest: to reduce by half the proportion of people living on less than $1 a day and to reduce by half the proportion of people who suffer from hunger. “Halving poverty” has come to serve as a touchstone for the MDGs as a whole. In addition, key international agencies, including the United Nations, the World Bank, the International Monetary Fund (IMF), the Organization for Economic Cooperation and Development (OECD), and the World Trade Organization (WTO), all helped develop the Millennium Declaration and so have a collective policy commitment to attacking poverty directly. The MDGs assign specific responsibilities to rich countries, including increased aid, removal of trade and investment barriers, and eliminating unsustainable debts of the poorest nations. CRITICISM OF MDG some observers believe that the MDG targets were not ambitious enough, going little beyond projecting past rates of improvement 15 years into the Future, Moreover, the goals were not prioritized; for example, reducing hunger may leverage the achievement of many of the other health and education targets. although the interrelatedness of development objective was implicit in the MDGs’ formulation, goals are presented and treat in reports as stand-alone objectives; in reality, the goals are not substitutes for the setting of 2015 as an end date for the targets could discourage rather than encourage further development assistance if it were not met. the MDGs measure poverty as the fraction of the population below the $1-a-day line, this is arbitrary and fails to account for the intensity of poverty—that a given amount of extra income to a family with a per capita income of, say, 70 cents a day makes a bigger impact on poverty than to a family earning 90 cents per day (see Chapter 5). Sustainable Development Goals With the imminent expiration of the MDGs, the UN coordinated global efforts to launch its successor, Sustainable Development Goals (SDGs) it is “a universal agenda” for all countries, developed as well as developing and without exceptions, “to be driven by five big, transformative shifts.” These universal shifts are: 1. Leave no one behind—to move “from reducing to ending extreme 1. Leave no one behind—to move “from reducing to ending extreme poverty, in all its forms;” in particular, to “design goals that focus on reaching excluded groups.” 2. Put sustainable development at the core, “to integrate the social, economic, and environmental dimensions of sustainability.” 3. Transform economies for jobs and inclusive growth, while moving to sustainable patterns of work and life.. 4. Build peace and effective, open, and accountable institutions for all, which “encourage the rule of law, property rights, freedom of speech and the media, open political choice, access to justice, and accountable government and public institutions.” 5. Forge a new global partnership so that each priority should involve governments and also others, including people living in poverty, civil society and indigenous and local communities, multilateral institutions, business, academia, and philanthropy. CHAPTER 2: COMPARATIVE ECONOMIC DEVELOPMENT Among countries colonized by European powers during the past 500 years, those that were relatively rich in 1500 are now relatively poor….The reversal reflects changes in the institutions resulting from European colonialism. — Daron Acemoglu, Simon Johnson, and James A. Robinson, 2002 Emerging powers in the developing world are already sources of innovative social and economic policies and are major trade, investment, and increasingly development cooperation partners for other developing countries. —Helen Clark, Administrator, United Nations Development Programme, 2012 There are also enormous gaps in measures of welfare. Life expectancy is 79 in the United States, 65 in India and just 48 in the DRC. The percent of children who are underweight is less than 3% in the United States but 43% in India and 24% in the DRC. Whereas almost all women are literate in the United States, just 51% are in India and 57% in the DRC. How did such wide disparities between developing and developed countries come about? In the age of globalization in which movement of people, information, and goods and services so rapid and comparatively inexpensive, how have such large gaps managed to persist and even widen? Why have some developing countries made so much progress in closing these gaps while others have made so little? 10 important common features of developing countries  These areas are the following: 1. Lower levels of living and productivity 2. Lower levels of human capital 3. Higher levels of inequality and absolute poverty 4. Higher population growth rates 5. Greater social fractionalization 6. Larger rural populations but rapid rural-to- urban migration. 7. Lower levels of industrialization, 8. Adverse geography, 9. Underdeveloped financial and other markets, 10. Lingering colonial impacts such as poor institutions and often external dependence. 2.1 Defining the Developing World The most common way to define the developing world is by per capita income. International agencies like Organization for Economic Cooperation and Development (OECD) and the United Nations, offer classifications of countries by their economic status, but the best-known system is that of the International Bank for Reconstruction and Development (IBRD), more commonly known as the World Bank. World Bank : is an organization known as an “international financial institution” that provides development funds to developing countries in the form of interest-bearing loans, grants, and technical assistance. In the World Bank’s classification system, 213 economies with a population of at least 30,000 are ranked by their levels of gross national income (GNI) per capita. Classification of Economies by World Bank In the World Bank’s classification system, 213 economies with a population of at least 30,000 are ranked by their levels of gross national income (GNI) per capita. These economies are then classified as: low-income countries , lower-middle-income countries , upper middle-income countries , high-income OECD countries, and other high-income countries. Often, LMCs and UMCs are informally grouped as The middle-income countries. With a number of important exceptions, the developing Classification of Economies by World Bank Low-income countries (LICs)- defined as having per capita gross national income in 2011 of $1,025 or less, Lower-middle-income countries (LMCs)- per capita GNI between $ 1,026 and $ 4,035; Upper middle-income countries (UMCs)- per capita GNI between $ 4,036 and $ 12,475; High-income OECD countries and other high-income countries - per capita GNI is $ 12,476 or more. (Often, LMCs and UMCs are informally grouped as the middle-income countries.) Some other categorisation of developing countries a number of the countries grouped as “other high- income economies”. Moreover, high-income countries that have one or two highly developed export sectors but in which significant parts of the population remain relatively uneducated or in poor health, or social development is viewed as low for the country’s income level, may be viewed as still developing. Examples may include oil exporters such as Saudi Arabia and the United Arab Emirates. Yet another way to classify the nations of the developing world is through their degree of international indebtedness, the World Bank has classified countries as : severely indebted, moderately indebted, and less indebted The United Nations Development Programme (UNDP) classifies countries according to their level of human development, including health and education attainments as low, medium, high, and very high. Another widely used classification is that of the least developed countries For inclusion, a country has to meet each of three criteria: low income, low human capital, and high economic vulnerability. Newly Industrializing countries (NICs) : Countries at a relatively advanced level of economic development with a substantial and dynamic industrial sector and with close links to the international trade, finance, and investment system. Least developed countries : A UN designation of countries with low income, low human capital, and high economic vulnerability. Human capital : Productive investments in people, such as skills, values, and health resulting from expenditures on education, on-the-job training programs, and medical care. Emerging market: was introduced at the International Finance Corporation to suggest progress. This term has certain implications. First, emerging market is widely used in the financial press to suggest the presence of active stock and bond markets; although financial deepening is important, it is only one aspect of economic development, Second, referring to nations as markets may lead to an under emphasis on some non-market priorities in development, Third, usage varies, and there is no established or generally accepted designation of which markets should be labeled as emerging and which as yet to emerge(the latter now sometimes dubbed frontier markets in the financial press). 2.2 Basic Indicators of Development: Real Income, Health, and Education In this section, we examine basic indicators of three aspects of development : real income per capita adjusted for purchasing power; health as measured by life expectancy, undernourishment, and child mortality; educational attainments as measured by literacy and schooling. GNI and GDP In accordance with the World Bank’s income-based classification of countries , Gross National Income (GNI) per capita, the most common measure of the overall level of economic activity, is often used as a base of the relative economic well-being of people in different countries. Gross National Income is calculated as the total domestic and foreign value added claimed by a country’s residents without making deductions for depreciation (or wearing out) of the domestic capital stock. In other words GNI is the total domestic and foreign output claimed by residents of a country, consisting of GDP plus factor incomes earned by foreign residents, minus income earned in the domestic economy by non residents, In Indian context GNI is total value addition by Indians(In India + in abroad). Gross domestic product (GDP) The total final output of goods and services- - produced by the country’s economy within the country’s territory, - by residents and nonresidents, regardless of its allocation between domestic and foreign claims.  In Indian context GDP will be measured as total value addition in India (By Indians and foreigners ).  In other words GNI is total value addition by Indians(In India and abroad), and GDP means total value addition in India(by resident and non residents or By Indians and foreigners) Value added : The portion of a product’s final value that is added at each stage of production. Depreciation (of the capital stock) : The wearing out of equipment, buildings, infrastructure, and other forms of capital, reflected in write-offs to the value of the capital stock. Capital stock : amount of physical good existing at a particular time that have been produced for use in the production of other goods and services. Why Purchasing Power Parity Per capita GNI comparisons between developed and less developed countries are however exaggerated by the use of official foreign-exchange rates to convert national currency figures into U.S. dollars.  This conversion does not measure the relative domestic purchasing power of different currencies. In an attempt to rectify this problem, researchers have tried to compare relative GNIs and GDPs by using purchasing power parity (PPP) instead of exchange rates as conversion factors. Purchasing Power Parity(PPP) Purchasing power parity(PPP): Calculation of GNI using a common set of international prices for all goods and services, to provide more accurate comparisons of living standards. In simple words PPP is defined as the number of units of a foreign currency required to purchase the same quantity of goods and services in the local developing country market. For example as one spends 25 US dollar to by some goods & services in the United States then how many US Dollar one would pay to buy the identical goods & services in the Indian market. Generally, prices of non traded services are much lower in developing countries because wages are so much lower. Clearly, if domestic prices are lower, PPP measures of GNI per capita will be higher than estimates using foreign exchange rates as the conversion factor. For example, China’s 2011 GNI per capita was only 10% of that of the United States using the exchange-rate conversion but rises to 17% when estimated by the PPP method of conversion. Income gaps between developed and developing nations thus tend to be less when PPP is used. Table 2.2 provides a comparison of exchange rate and PPP GNI per capita for 30 countries, 10 each from Africa, Asia, and Latin America, plus Canada, the United Kingdom and the United States. In the first column of Table 2.2, incomes are measured at market or official exchange rates and suggest that income of a person in the United States is 242 times that of a person in the DRC. But this is unbelievable, as many services cost much less in the DRC than in the United States. Thus it is clear that the PPP rates give a better sense of the amount of goods and services that could be bought evaluated at U.S. prices and suggest that real U.S. incomes are closer to 135 times that of the DRC. Overall, the average real (PPP) income per capita in high-income countries is more than 28 times that in low-income countries and more than 5 times higher than in middle-income countries. Indicators of Health and Education Besides average incomes, it is necessary to evaluate a nation’s average health and educational attainments, which reflect core capabilities. Life expectancy is the average number of years newborn children would live if subjected to the mortality risks prevailing for their cohort at the time of their birth. Undernourishment means consuming too little food to maintain normal levels of activity; it is what is often called the problem of hunger. High fertility can be both a cause and a consequence of underdevelopment, so the birth rate is reported as another basic indicator. Literacy is the fraction of adult males and females reported or estimated to have basic abilities to read and write; functional literacy is generally lower than the reported numbers. 2.3 Holistic Measures of Living Levels and Capabilities The New Human Development Index, The most widely used measure of the comparative status of socioeconomic development is presented by the United Nations Development Programme (UNDP) in its annual series of Human Development Reports. The centerpiece of these reports, which were initiated in 1990, is the construction and refinement of its informative Human Development Index (HDI). This section examines the New HDI, initiated in 2010 (the well- known traditional HDI—the UNDP centerpiece from 1990–2009—is examined in detail in Appendix 2.1). Box 2.2 summarizes “What Is New in the New HDI. Human Development Index (HDI) An index measuring national socioeconomic development, based on combining measures of education, health, and adjusted real income per capita. The New HDI , like its predecessor, ranks each country on a scale of 0 (lowest human development) to 1 (highest human development) based on three goals or end products of development: Long and healthy life as measured by life expectancy at birth; Knowledge as measured by a combination of average schooling attained by adults and expected years of schooling for school-age children; and Decent standard of living as measured by real per capita gross domestic product adjusted for the differing purchasing power parity of each country’s currency to reflect cost of living and for the assumption of diminishing marginal utility of income Diminishing marginal utility :The concept that the subjective value of additional consumption lessens as total consumption becomes higher. Calculating the New HDI There are two steps in calculating the New HDI: first, creating the three “dimension indices”; and second, aggregating the resulting indices to produce the overall New Human Development Index (NHDI). After defining the relevant minimum and maximum values (or lower and upper “goalposts”), each dimension index is calculated as a ratio that basically is given by the percent of the distance above the minimum to the maximum levels that a country has attained Calculating the New HDI Dimension index = Actual Value – Min. Value / Max. Value – Min. Value Using these three measures of development and applying the formula to data for all 187 countries for which data is available, HDI currently ranks countries into four groups: Low human development (0.0 to 0.535), Medium human development (0.536 to 0.711), High human development (0.712 to 0.799), and Very high human development (0.80 to 1.0). Calculating the New HDI The component indexes of the NHDI are first computed by taking the difference between the country’s actual achievement and the minimum goalpost value, and then dividing the result by the difference between the overall maximum goalpost and minimum goalpost values. But in calculating the overall index, in place of the arithmetic mean, a geometric mean of the three indexes is used (a geometric mean is also used to build up the overall education index from its two components). What is new in the New HDI? 1. Calculating with a geometric mean. Probably most consequential: The index is now computed with a geometric mean, instead of an arithmetic mean A geometric mean is also used to build up the overall education index from its two components Traditional HDI added the three components and divided by 3 New HDI takes the cube root of the product of the three component indexes The traditional HDI calculation assumed one component traded off against another as perfect substitutes, a strong assumption The reformulation now allows for imperfect substitutability What is new in the New HDI ? 2. Other key changes Gross national income per capita replaces gross domestic product per capita Revised education components: now using the average actual educational attainment of the whole population, and the expected attainment of today’s children The maximum values in each dimension have been increased to the observed maximum rather than given a pre-defined cutoff The lower goalpost for income has been reduced due to new evidence on lower possible income levels. The UNDP now also offers the- Inequality-Adjusted Human Development Index (IHDI)—which imposes a penalty on the HDI that increases as inequality across people becomes greater —and The Gender Inequality Index (GII), as well as an important innovation, The Multidimensional Poverty Index (MPI), Significance of HDI The Human Development Index, in its Traditional as well as New forms, has made a major contribution to improving our understanding of what constitutes development, Which countries are succeeding (as reflected by rises in their NHDI over time), and How different groups and regions within countries are faring. By combining social and economic data, the NHDI allows nations to take a broader measure of their development performance, both relatively and absolutely. Significance of HDI The New HDI and its Traditional version when used in conjunction with other economic measures of development greatly increase our understanding of which countries are experiencing development and which are not. By modifying a country’s overall NHDI to reflect income distribution, gender, regional, and ethnic differentials, we are now able to identify not only whether a country is developing but also whether various significant groups within that country are participating in that development 2.4 Characteristics of the Developing World: Diversity within Commonality There are important historical and economic commonalities among developing countries that have led to their economic development. At the same time, however, there is a great deal of diversity throughout the developing world, even within these areas of broad commonality. Different development problems call for different specific policy responses and general development strategies. This section examines the 10 major areas of “diversity within commonality” in the developing world. 10 Characteristics of the Developing World: Diversity within Commonality 1. Lower Levels of Living and Productivity, 2. Lower Levels of Human Capital, 3. Higher Levels of Inequality and Absolute Poverty, 4.Higher Population Growth Rates, 5. Greater Social Fractionalization, 6. Larger Rural Populations but Rapid Rural- to-Urban Migration, 7. Lower Levels of Industrialization and Manufactured Exports 8.Adverse Geography, 9. Underdeveloped Markets, 10. Lingering Colonial Impacts and Unequal 1.a.Lower Levels of Living and Productivity There is a vast gulf in productivity between advanced economies such as the United States and developing nations, including India and the DRC, but also a wide range among these and other developing countries. Low level of living standard and productivity is common feature of developing word. In very low income countries a vicious circle of poverty or poverty trap may be found in which low income leads to low investment in education and health ,plant and equipment and infrastructure, which in turn leads to low productivity. Nobel laureate Gunnar Myradal has called it circular and cumulative causation. 1.b.Lower Levels of Living and Productivity The low-income countries are themselves a very diverse group with greatly differing development challenges. There is also a large gap in productivity among developing nations,. Among developing countries the wide disparity in income is largely related to the large gaps in output per worker, for example in 2011 it was 6 in sub sahara,9 in southern Asia,10 in south east Asia,14 in eastern Asia and 21 in northern Africa. Further ,income growth rates have varied greatly in different developing regions and countries, with rapid growth in East Asia, slow or even no growth in sub- Saharan Africa, and intermediate levels of growth in other regions. Some middle income countries are also relatively stagnant, but others are growing rapidly—China most spectacularly. 2.a. Lower Levels of Human Capital Human capital—health, education, and skills—is vital to economic growth and human development. We have already observed the great disparities in human capital around the world while discussing the Human Development Index. Compared with developed countries, much of the developing world has lagged in its average levels of nutrition, health (as measured by life expectancy or undernourishment), and education (measured by literacy). 2.b. Lower Levels of Human Capital The well-performing developing countries are much closer to the developed world in health and education standards than they are to the lowest income countries. Although health conditions in East Asia are relatively good, sub-Saharan Africa continues to be plagued by problems of malnourishment, malaria, tuberculosis, AIDS, and parasitic infections. Despite progress, South Asia continues to have high levels of illiteracy, low schooling attainment, and undernourishment. In primary school completion, low income countries are also making great progress; for example, enrollments in India are up from 68% in the early 1990s to a reported 94% by 2008. 3.a.Higher Levels of Inequality and Absolute Poverty The enormous gap in per capita incomes between rich and poor nations is a major indicator of the huge global economic disparities. But at the same time it is necessary to look at the gap between rich and poor within individual developing countries. Inequality varies greatly among developing countries, it is particularly high in many resource-rich developing countries, notably in the Middle East and sub-Saharan Africa but generally much lower inequality in Asia. A large majority of the extreme poor live in the low-income developing countries of sub-Saharan Africa and South Asia. Here extreme poverty is due to low human capital , social and political exclusion and other deprivations Several African countries, including Sierra Leone and South Africa, also have among the highest levels of inequality in the world. 3.b.Higher Levels of Inequality and Absolute Poverty Absolute Poverty-Development economists use this concept to represent a specific minimum level of income needed to satisfy the basic physical needs of food, clothing, and shelter in order to ensure continued survival. The incidence of extreme poverty varies widely around the developing world. The World Bank estimates that the share of the population living on less than $1.25 per day is 9.1% in East Asia and the Pacific, 8.6% in Latin America and the Caribbean, 1.5% in the Middle East and North Africa, 31.7% in South Asia, and 41.1% in sub-Saharan Africa. 3.c.Higher Levels of Inequality and Absolute Poverty The share of the world population living below this level had fallen encouragingly to an estimated 21% by 2010, the number living on less than $1.25 per day fell from about 1.9 billion in 1981 to about 1.2 billion by 2008, despite a 59% increase in the developing world’s population. Extreme poverty represents great human misery, and so redressing it is a top priority of international development. Development economists have also increasingly focused on ways in which poverty and inequality can lead to slower growth. That is, not only do poverty and inequality result from distorted growth, but they can also cause it. 4.a. Higher Population Growth Rates Global population has skyrocketed since the beginning of the industrial era from just under 1 billion in 1800 to 1.65 billion in 1900 and to over 6 billion by 2000 and it crossed 7 billion by 2012.But in recent decades, most population growth has been centered in the developing world. Compared with the developed countries, which often have birth rates near or even below replacement (zero population growth) levels, the low-income developing countries have very high birth rates. More than five-sixths of all the people in the world now live in developing countries; and some 97% of net population growth (births minus deaths) in 2012 took place in developing regions. 4.b. Higher Population Growth Rates But population dynamics varies widely among developing countries. From 1990 to 2008, population in the low-income countries grew at 2.2% per year, compared to 1.3% in the middle-income countries. Middle-income developing countries show greater variance, with some having achieved lower birth rates closer to those prevailing in rich countries. Intermediate but still relatively high birth rates are found in South Asia (24), the Middle East and North Africa (24). East Asia and the Pacific have a moderate birth rate of 14 per 1,000, partly the result of birth control policies in China Crude birth rate- The number of children born alive each year per 1,000 population. 4.c. Higher Population Growth Rates A major implication of high birth rates is that the active labor force has to support proportionally almost twice as many children as it does in richer countries. Dependency burden -The proportion of the total population aged 0 to 15 and 65+, which is considered economically unproductive and therefore not counted in the labor force. Both older people and children are often referred to as an economic dependency burden in the sense that they must be supported financially by the country’s labor force. 4.d. Higher Population Growth Rates By contrast, the proportion of people over the age of 65 is much greater in the developed nations but in rich countries, older citizens are supported by their lifetime savings and by public and private pensions. In contrast, in developing countries, public support for children is very limited. So dependency has a further magnified impact in developing countries. Therefore, that not only are developing countries characterized by higher rates of population growth, but they must also have to deal with greater dependency burdens than rich nations, though with a wide difference between low- and middle-income developing countries. 5.a.Greater Social Fractionalization Fractionalization -Significant ethnic, linguistic, and other social divisions within a country. Low-income countries often have ethnic, linguistic, and other forms of social divisions, sometimes known as fractionalization. This is sometimes associated with civil strife and even violent conflict, which can lead developing societies to divert considerable energies to working for political accommodations if not national consolidation. There is some evidence that many of the factors associated with poor economic growth performance in sub-Saharan Africa, such as low schooling, political instability, underdeveloped financial systems, and insufficient infrastructure, can be statistically explained by high ethnic fragmentation. 5.b.Greater Social Fractionalization The greater the ethnic, linguistic, and religious diversity of a country, the more likely it is that there will be internal strife and political instability. Some of the most successful development experiences South Korea, Taiwan, Singapore, and Hong Kong have occurred in culturally homogeneous societies in other words ethnic problems were not there. But today, more than 40% of the world’s nations have more than five significant ethnic populations. In most cases, one or more of these groups face serious problems of discrimination, social exclusion, or other systematic disadvantages. Over half of the world’s developing countries have experienced some form of interethnic conflict. 5.c.Greater Social Fractionalization Ethnic and religious conflicts leading to widespread death and destruction have taken place in countries as diverse as Afghanistan, Rwanda, Mozambique, Guatemala, Mexico, Sri Lanka, Iraq , Kyrgyzstan, Somalia, Ethiopia , Myanmar, Sudan, the former Yugoslavia , Indonesia. Throughout Latin America, indigenous populations have significantly lagged behind other groups on almost every measure of economic and social progress. Whether in Bolivia, Brazil, Peru, Mexico, indigenous groups have benefited little from overall economic growth. 5.d.Greater Social Fractionalization  But is also true that ethnic and religious diversity need not necessarily lead to inequality, turmoil or instability.  There have been numerous instances of successful economic and social integration of minority or indigenous ethnic populations in countries as diverse as India ,Malaysia and Mauritius. The important point is whether the ethnic and religious composition or diversity of a developing nation leads to conflict or cooperation can be important determinants of the success or failure of development efforts. 6.a.Larger Rural Populations but Rapid Rural-to-Urban Migration Region Population (millions Urban share (%) 2009) World 6810 50 More developed 1232 75 countries Less developed 5578 44 countries Sub Saharan Africa 836 35 Nothern Africa 205 50 Latin America & 580 77 C.Sea West Asia 231 64 South Central Asia 1726 31 South East Asia 597 43 East Asia 1564 51 6.b.Larger Rural Populations but Rapid Rural-to-Urban Migration One of the major characteristics of economic development today is a shift from agriculture to manufacturing and services. The share of urban population in the world as a whole has crossed 50% as seen in previous slide.It means more people live in cities than in rural areas. As far as developing countries are concerned, a much higher share of the population lives in rural areas, and correspondingly fewer in urban areas, as seen in Table on previous slide. But a massive population shift is also under way as hundreds of millions of people are moving from rural to urban areas, fueling rapid urbanization But at the same time sub-Saharan Africa and most of Asia still remain predominantly rural. 7.a.Lower Levels of Industrialization and Manufactured Exports Industrialization is associated with high productivity and incomes and has been a hallmark of modernization and national economic power. That is why most developing countries have made industrialization a high national priority, with a number of prominent success stories in Asia. Generally, developing countries have a far higher share of employment in agriculture than developed countries. Moreover , in developed countries, agriculture represents a very small share of both employment and output. For example it is about 1% to 2% in Canada, the United States and United Kingdom. 7.b.Lower Levels of Industrialization and Manufactured Exports In Madagascar while about 82% of both men and women worked in agriculture , it represented only a quarter of total output. In Indonesia, 41% of both men and women worked in agriculture, but it represented just 14% of output. There is also a gender perspective in this regard.For example in Latin America a significantly higher proportion of men work in agriculture than women; But in many countries in Africa and Asia, a larger proportion of women work in agriculture. 7.c.Lower Levels of Industrialization and Manufactured Exports Structural transformation of employment has been occurring in developing countries. During 1990-1992 to 2008-11 there have been substantial declines over this two- decade period in the share in employment in agriculture in most developing countries. For example, in Indonesia the proportion of men who work in agriculture fell from 54% to 37%; and the proportion of women who work in agriculture fell from 57% to 35%. 7.d.Lower Levels of Industrialization and Manufactured Exports At the same time, the share of employment in industry in many developed countries is smaller now than in some developing countries, particularly among women, as developed countries continue their secular trend to switch to from industry to service sector employment. Relatively few countries managed a substantial gain of the fraction in manufacturing in this period; Indonesia, Turkey, and Mexico showed modest gains, particularly for men. Other evidence indicates that a large fraction of global manufacturing jobs were gained in one country—China—during this period; but comparable data for China were unavailable for comparison. But the share of industrial employment in Africa remains low for both men and women in most countries 7.e.Lower Levels of Industrialization and Manufactured Exports Along with lower industrialization, developing nations tended to have a higher dependence on primary export. Most developing countries have diversified away from agricultural and mineral exports to some degree. The middle income countries are rapidly catching up with the developed world in the share of manufactured goods in their exports. However, the low-income countries , particularly those in Africa, remain highly dependent on a relatively small number of agricultural and mineral exports. 8. a. Adverse Geography Many analysts argue that geography must plays some role in problems of agriculture , public health, and comparative development. For example Landlocked economies, common in Africa, often have lower incomes than coastal economies. Developing countries are primarily tropical or subtropical, and this has meant that they suffer more from tropical pests and parasites, endemic diseases such as malaria, water resource constraints, and extremes of heat. Even global warming is projected to have its greatest negative impact on Africa and South Asia 8.b. Adverse Geography The extreme case of favorable physical resource endowment is the oil rich Persian Gulf states. At the other extreme are countries like Chad, Yemen, Haiti, and Bangladesh, where endowments of raw materials and minerals and even fertile land are relatively minimal. Resource endowment : A nation’s supply of usable factors of production, including mineral deposits, raw materials , and labour. Clearly, geography is not destiny; high-income Singapore lies almost directly on the equator, and parts of southern India have exhibited enormous economic dynamism in recent years 9.a.Underdeveloped Markets Imperfect markets and incomplete information are far more prevalent in developing countries, with the result that domestic markets, notably but not only financial markets, have worked less efficiently. Some aspects of market underdevelopment are that they often lack – (1) a legal system that enforces contracts and validates property rights; (2) a stable and trustworthy currency; (3) an infrastructure of roads and utilities that results in low transport and communication costs so as to facilitate interregional trade; 9.b.Underdeveloped Markets (4) a well-developed and efficiently regulated system of banking and insurance, with broad access and with formal credit markets that select projects and allocate loanable funds on the basis of relative economic profitability and enforce rules of repayment; (5) substantial market information for consumers and producers about prices, quantities, and qualities of products and resources as well as the creditworthiness of potential borrowers; and (6) social norms that facilitate successful long- term business relationships 9.c.Underdeveloped Markets Imperfect market : A market in which the theoretical assumptions of perfect competition are violated by the existence of, for example, a small number of buyers and sellers, barriers to entry, and incomplete information. Incomplete information : The absence of information that producers and consumers need to make efficient decisions resulting in underperforming markets. 10.a.Lingering Colonial Impacts and Unequal International Relations Colonial Legacy : Most developing countries were once colonies of Europe or otherwise dominated by European or other foreign powers, Institutions created during the colonial period often had harmful effects on development. Both domestically and internationally, developing countries have more often lacked institutions and formal organizations of the type that have benefited the developed world. Even several decades after independence, the effects of the colonial era linger for many developing nations, particularly the least developed ones. 10.b.Lingering Colonial Impacts and Unequal International Relations External Dependence : Relatively , developing countries have also been less well organized and influential in international relations, with sometimes adverse consequences for development. For example, agreements within the World Trade Organization (WTO) and its predecessors, concerning matters, such as agricultural subsidies in rich countries that harm developing-country farmers and one-sided regulation of intellectual property rights have often been relatively unfavorable to the developing world. 10.c.Lingering Colonial Impacts and Unequal International Relations More generally, developing nations have weaker bargaining positions than developed nations in international economic relations. Developing nations are also dependent on the developed world for environmental preservation, on which hopes for sustainable development depend. One of the greatest concern is that global warming is projected to harm developing regions more than developed ones; yet both accumulated and current greenhouse gas emissions still largely originate in the high-income countries, despite the role of developing-country deforestation and growing emissions from lower middle-income countries such as China and India. 2.5 How Low-Income Countries Today Differ from Developed Countries in Their Earlier Stages: Physical and Human Resource Endowments Most less developed countries are poorly endowed (especially Asia). Also parts of Africa and Latin America require heavy investment to exploit the resources The difference in skilled human resource endowments is even more pronounced Romer: the technology gap between rich and poor nations are divided into an object gap (factories, roads, etc) and an idea gap (also called ingenuity gap: business knowledge, worker motivation, etc)  No such human resource gaps existed for now developed countries on the eve of industrialization. Relative Levels of Per Capita Income and GDP Living standards of now developed were not great during industrialization, but they certainly weren’t economically debilitating as Climatic Differences Economically most successful countries are located in the temperate zone – this dichotomy cannot be ignored, although the effects of climate might be explanatorily limiting on the greater scheme of inequality etc. Population Size, Distribution, and Growth Before and during their early growth years, Western nations experienced a very slow rise in population growth – this is not the case for most developing countries now. The Historical Role for International Migration International migration was a major outlet for excess rural population in the 19th and early 20th century – home governments were relieved of costs of providing for the unemployed, plus a not insignificant portion of foreign earnings were being sent back home Mass emigration has very little scope for reducing pressures of overpopulation in developing countries now US: immigration has been a problem and people feel like immigrants are taking advantage = backlash against them – Proposition 187 in California taking away benefits.. Also many of the people who immigrate are the ones that are most needed by the home countries, aka the educated and skilled – they move permanently = “brain drain”  loss of valuable human resources Paradoxically, might be benefit of “brain gain” where people might be encouraged to acquire skills The Growth Stimulus of International Trade Non-oil exporting developing countries are unable to generate rapid economic growth through world trade – their terms of trade have declined over years (price received for exports relative to price to be paid for imports) When developing countries become lower-cost producers of competitive products with developed countries, the latter set up barriers to trade (tariff and non) Basic Scientific and Technological Research and Development Capabilities Scientific and technological advance largely concentrated in rich countries Poor countries do not have the financial resources or the scientific and technological know-how to undertake the kind of research and development (R&D) that is in their economic long- term interest. Not in advance over anyone… Efficacy of Domestic Institutions Douglass North: “even if the formal rules may be changed overnight, informal rules usually change only ever so gradually” Developed countries also usually enjoyed relatively stronger political stability and more flexible social institutions with broader access to mobility. Especially in Africa, colonizers more arbitrarily determined national boundaries. 4.6 Are Living Standards of Developing and Developed Nations Converging? Divergence: A tendency for per capita income (or output) to grow faster in higher-income countries than in lower-income countries so that the income gap widens across countries over time (as was seen in the two centuries after industrialization began). Convergence: The tendency for per capita income (or output) to grow faster in lower-income countries than in higher-income countries so that lower-income countries are “catching up” over time. When countries are hypothesized to converge not in all cases but other things being equal (particularly savings rates, labor force growth, and production technologies), then the term conditional convergence is used. At the dawn on the industrial era, real living standards in richest countries were no more than 3 times as great as poorest countries – now, ratio is almost 100 to 1. If growth experience were similar, technology transfer and more rapid capital accumulation would explain that developing countries are catching-up by growing faster on average than developed countries. Technology transfer: developing countries could “leapfrog” over earlier stages of technological development, learn from past mistakes and move to high-productivity methods ▪By some examples, the later a country begins modern economic growth, the faster they can double output per worker. More rapid capital accumulation: law of diminishing returns dictates that the impact of additional capital on output should be smaller in developed countries who have a lot of capital already, whereas it is scarce in developing countries. Although China and South Asia have had larger growth rates than OECD countries in 1990-2003 period, many of the poorest countries remain in relative stagnation. Evidence of unconditional convergence is hard to find but there is increasing evidence of “per capita income convergence,” weighting changes in per capita income by population size. 2.7 Long-Run Causes of Comparative Development Now we will discuss comparative economic development to further clarify how such an unequal world came about and remained so persistently unequal, and We examine other factors in comparative development, such as nations’ levels of inequality. We will come to appreciate why so many developing countries have such difficulties in achieving economic development. In other words we will see a schematic framework for appreciating the major long-run causes of comparative development. Clonialism-1 It is quite clear that colonialism played a major role in shaping institutions that set the “rules of the economic game,” which can limit or facilitate opportunities for economic development. Most developing countries were once colonies. In the colonies, unfavorable institutions were therefore established by colonial powers, favoring extraction over production incentives. It has been argued that for various reasons, earlier colonization generally involved more plunder and less active production than later colonization, although both happened at the cost of the indigenous populations. Clonialism-2 Early development in Europe gave it advantages over most other regions—advantages that were used to colonize much of the world. Geography undoubtedly influenced early economic history in Europe In particular Europeans brought better agricultural techniques to the later-settled areas such as North America. Thus, pre colonial (potential) comparative advantage again mattered. The possible role played by specific skills also points up the importance of human capital investments for development. Thus, the types of colonial regimes established, while always designed for the benefit of the colonizers, were influenced by local and European supply and demand factors. The type of regime had enormous influence on postcolonial institutional quality Physical Geography-1 Some economists doubt that physical geography, including climate, has had an important impact on economic history. However, for example, there is some evidence of an independent impact of malaria and indications that in some circumstances, landlocked status may be an impediment to economic growth; Geography affected the types of colonies established. It can be understood by seeing the effect of geographic features for example settler mortality rates. When potential settlers faced higher mortality rates or perhaps other high costs, they more often ruled at arm’s length and avoided large, long-term settlement. Physical Geography-2 For example pre colonial comparative advantage and labor abundances in the Americas and their relation to the institutions established can be seen. When climate was suitable for plantation agriculture (particularly sugarcane in the early history), slavery and other types of mass exploitation of indigenous labour were introduced. In other areas like Spain, when indigenous peoples were in sufficient numbers and mineral wealth was available, vast land grants were established. Although resulting from different comparative advantage (for example-sugarcane and minerals) economic and political inequality remained high in all of these economies which had long-lasting negative effects on development. Economic Institutions Economic Institutions plays an important role in comparative development. It shapes interactions or “rules of the game” in an economy, including : formal rules embodied in constitutions, laws, contracts, and market regulations, plus informal rules reflected in norms of behavior and conduct, values, customs, and generally accepted ways of doing things. In other words economic institutions provide the base for a market economy by establishing - the rules of property rights and contract enforcement; improving coordination; restricting coercive, fraudulent, and anticompetitive behavior; providing access to opportunities for a broad population; constraining the power of elites; and managing conflict more generally. Inequalities-1 Early inequities were perpetuated because in the colonies there were limits on the non elite population’s access to land, education, finance, property protection, and voting rights, as well as labor markets. This prevented opportunities to take advantage of industrialization ,when they emerged in the nineteenth century, a period when broad participation in commercial activity had high social returns. Besides creating specific institutions, European colonization created or reinforced differing degrees of inequality , ultimately leading to diminished prospects for growth and development, notably in Latin America and the Caribbean. Inequalities-2  The degree of inequality itself can shape the evolution of institutions as well as specific policies. Where inequality was extreme, there was less investment in human capital and other public goods and a tendency of less movement toward democratic institutions. Thus, extreme inequality is likely to be a long-term factor in explaining comparative development. This is raised in the striking historical contrast between the states of North America and the states of Central and South America. Human Capital-1 Institutional quality affects the amount and quality of investments in education and health. In countries with higher levels of education, institutions tend to be more democratic, with more constraints on elites. human capital is at least as fundamental a source of long-run development as institutions. However, in some cases extractive colonial institutions left a legacy that resulted in poor health and education decades after independence , an example from India. Human Capital-2 Human capital has a direct impact on income and on human development. The depth and breadth of education in the population will help determine the effectiveness of government as a force for development. This is due not only to a better-qualified civil service but also to the understanding of citizens of poor government performance and the knowledge of how to work for a better outcome and capacity to organize. Of course, education could also independently affect the organization and functioning of markets Postcolonial institutions-1 Postcolonial institutional quality has a strong impact on the effectiveness of the private, public, and citizen (or civil society) sectors. Democratic governance , rule of law, and constraints on elites will encourage more and better quality public goods, Better property rights protections and contract enforcement for ordinary citizens and broad access to economic opportunities will encourage private investments. And institutions will affect the ability of civil society to organize and act effectively as a force independent of state and market. Suggestions-1 It is not yet entirely clear which economic institutions are most important in facilitating development. But a key finding of recent research is that, forces, that protect narrow elites in ways that limit access of the broader population to opportunities for advancement are major obstacles to successful economic development. Nevertheless, in most countries with poor institutions, there is still much that can be done to improve human welfare and to encourage the development of better institutions. Suggestions-2. Although the evidence of the impact of democracy on growth in the short term is not strong, in the long run democratic governance and genuine development do go hand in hand. The steady spread of more genuinely democratic institutions in the developing world is very encouraging sign. Development strategies that lead to greater human capital, improve access to new technologies, produce better-quality public goods, improve market functioning, address deep-rooted problems of poverty, improve access to finance, prevent environmental degradation, and foster a vibrant civil society all promote development. Suggestion-3  The type and quality of global integration (particularly trade) have been stressed as a boon to long-run growth and development in many World Bank reports. Trade may be beneficial in that it provides various kinds of access to technology. Greater openness to trade beneficially affects the subsequent evolution of institutions. Some research suggests that when other factors are taken into account, geography adds little to our understanding of development levels. Arrow 2: geography could affect types of colonies established – when potential settlers faced higher mortality rates, they often kept arm’s-length = “steal-fast-and-get-out” = unfavorable institutions favoring extraction over production incentives Arrow 3: those with more bargaining power to ask for better treatment … Accemoglu: after accounting for institutional differences, geographic variables have little influence on incomes today. Arrow 4: influence of geography on precolonial institutions Arrow 5: precolonial institutions also mattered to the extent that they had influence over the type of colonial regimes established. In Americas, scarce labour with abundant land inhibited the concentration of power (despite efforts of colonizers to do so). The need to attract more settlers and encourage them to engage the colonial economy led to the evolution of more egalitarian institutions in North American colonies. Arrow 8: geography undoubtedly influenced early economic history in Europe, leading to evolution and timing of European development. Arrow 9: timing of European development influenced the type of colonial regime established – earlier colonization generally involved more plunder and less active production than later colonization, although both at expense of indigenous population. Arrow 10: type of regime had enormous influence on postcolonial institutional quality Arrow 11: colonization created or enforced inequality (especially ethnic), leading to lesser prospects for growth and development Where inequality was extreme, there was less investment in human capital (arrow 13) and other public goods (arrow 16), and as reflected by the bidirectional arrow 12, a tendency of less movement toward democratic institutions Arrow 14: human capital has a direct impact on income and human development Arrow 15: the depth and breadth of education in the population will help determine the effectiveness of government as a force for development. – better qualified civil service, better organizational capacities, better recognition of poor government and how to work towards better outcomes… Arrow 17: democratic governance, rule of law, and constraints on elites will encourage more and better quality public – will spur private investment (arrow 18) Arrow 19: institutions will affect ability of civil society to organize and act independently of market and state Arrows 20, 21, 22: activities of the three sectors will each have influence on productivity and incomes, and on human development more generally. “Clearly there are multiple paths to economic development. But a key finding is that forces that protect narrow elites in ways that limit access of the broader population to opportunities for advancement are major obstacles to successful economic development. If institutions are highly resistant to attempts at reform, this helps clarify why development is so challenging.” Dani Rodrik: “participatory and decentralized political systems are the most effective ones we have for processing and aggregating local knowledge. We can think of democracy as a meta-institution for building other good institutions” Conclusion One can learn valuable lessons from economic policies that have been tried in various countries around the world. However, for most poor countries, backwardness comes with severe disadvantages, many of which have been compounded by legacies of colonialism, slavery, and Cold War dictatorships. CASE STUDY: Pakistan and Bangladesh ▪Bangladesh declares independence from Pakistan in 1971  wide disparities at separation, with Pakistan much better off. ▪ Interesting to compare because about the same population, both are in South Asian region, are both overwhelmingly Islamic, and both were once part of colonial British Raj of India. ▪Pakistan: “growth without development“ ▪Bangladesh: although poor, is transforming to a symbol of hope ▪Growth  PPP-adjusted incomes remain slightly higher in Pakistan, but Bangladesh is on a trend to surpass Pakistan. ▪Poverty  Bangladesh has fewer in poverty ▪Education and Literacy  literacy has been growing in Bangladesh (although at low 41% in both countries), but with greater gender equality in Bangladesh – also, clear edge in combined school enrollments ▪Health  similar life expectancies, but under-5 mortality rates have fallen dramatically in Bangladesh, while staying steadily high in Pakistan. ▪HDI  Bangladesh achieved middle human development status before Pakistan, but Pakistan has now surpassed Bangladesh perhaps due to growth from aid associated with war on terror. Population  fertility has fallen in Bangladesh Geography  Bangladesh at considerable disadvantage Bangladesh is very ethnically homogenous; Pakistan is not. Governance and role of military military withdrawal from politics in 90s in Bangladesh as probable factor in progress; military is very present in Pakistani politics ‒Both have very weak governments, not democratic, hardly transparent ‒But, Bangladesh has one of the most vibrant NGO sectors in the world. Chapter 3 Classic Theories of Economic Growth and Development 3.1 Classic Theories of Economic Development: Four Approaches Linear stages of growth model Theories and Patterns of structural change International-dependence revolution Neoclassical, free market counterrevolution Classic Theories of Economic Growth and Development There is no Economic Theory of Everything, — Robert Solow, Nobel laureate in economics [In] modern economic growth…the rate of structural transformation of the economy is high. —Simon Kuznets, Nobel laureate in economics Every nation strives after development. Economic progress is an essential component. In an ultimate sense, it must encompass more than the material and financial side of people’s lives, to expand human freedoms. Development should therefore be perceived as a multidimensional process involving the reorganization and reorientation of entire economic and social systems. In addition to improvements in incomes and output, it typically involves radical changes in institutional, social, and administrative structures as well as in popular attitudes and even customs and beliefs. Finally, although development is usually defined in a national context, its more widespread realization may necessitate modification of the international economic and social system as well. In this chapter, we explore the historical and intellectual evolution in scholarly thinking about how and why development does or does not take place. We do this by examining four major and often competing development theories. The classic post–World War II literature on economic development has been dominated by four major and sometimes competing strands of thought: (1) the linear-stages-of-growth model, (2) theories and patterns of structural change, (3) the international-dependence revolution, and (4) the neoclassical, free market counterrevolution. In recent years, an eclectic approach has emerged that draws on all of these classic theories Stages-of-growth model of development. A theory of economic development, associated with the American economic historian Walt W. Rostow, according to which a country passes through sequential stages in achieving development Structural-change theory. The hypothesis that underdevelopment is due to underutilization of resources arising from structural or institutional factors that have their origins in both domestic and international dualism. Development therefore requires more than just accelerated capital formation. Dependence. The reliance of developing countries on developed-country economic policies to stimulate their own economic growth. Dependence can also mean that the developing countries adopt developed-country education systems, technology, economic and political systems, attitudes, consumption patterns, dress, and so on. Dominance. In international affairs, a situation in which the developed countries have much greater power than the less developed countries in decisions affecting important international economic issues, such as the prices of agricultural commodities and raw materials in world markets. Neocolonial dependence model. A model whose main proposition is that underdevelopment exists in developing countries because of continuing exploitative economic, political, and cultural policies of former colonial rulers toward less developed countries. 3.2 Development as Growth and Linear-Stages Theories A Classic Statement: Rostow’s Stages of Growth Harrod-Domar Growth Model (sometimes referred to as the AK model) The Harrod-Domar Model - Simplified Version The Harrod-Domar Model - Simplified Version The Harrod-Domar Model – Incorporating Capital Depreciation Equation 3.7 is also often expressed in terms of gross savings, in which case the growth rate is given by (3.7’) where δ is the rate of capital depreciation But there is now growing evidence of “per capita income convergence,” weighting changes in per capita income by population size (Also, in chapter 3, we return to examine the concept of conditional convergence when we study the Solow model) Criticisms of the Stages Model Necessary versus sufficient conditions 3.3 Structural-Change Models The Lewis two-sector model Figure 3.1 The Lewis Model of Modern-Sector Growth in a Two-Sector Surplus-Labor Economy Criticisms of the Lewis Model Rate of labor transfer and employment creation may not be proportional to rate of modern-sector capital accumulation Surplus labor in rural areas and full employment in urban? Institutional factors? Assumption of diminishing returns in modern industrial sector Figure 3.2 The Lewis Model Modified by Laborsaving Capital Accumulation: Employment Implications Empirical Patterns of Development - Examples Switch from agriculture to industry (and services) Rural-urban migration and urbanization Steady accumulation of physical and human capital Population growth first increasing and then decreasing with decline in family size 3.4 The International-Dependence Revolution The neocolonial dependence model Legacy of colonialism, Unequal power, Core-periphery The false-paradigm model Pitfalls of using “expert” foreign advisors who misapply developed-country models The dualistic-development thesis Superior and inferior elements can coexist; Prebisch-Singer Hypothesis Criticisms and limitations Does little to show how to achieve development in a positive sense; accumulating counterexamples 3.5 The Neoclassical Counterrevolution: Market Fundamentalism Challenging the Statist Model: Free Markets, Public Choice, and Market-Friendly Approaches Free market approach Public choice approach Market-friendly approach Main Arguments Denies efficiency of intervention Points up state owned enterprise failures Stresses government failures Traditional neoclassical growth theory - with diminishing returns, cannot sustain growth by capital accumulation alone 3.6 Classic Theories of Development: Reconciling the Differences Governments do fail, but so do markets; a balance is needed Must attend to institutional and political realities in developing world Development economics has no universally accepted paradigm Insights and understandings are continually evolving Each theory has some strengths and some weaknesses Concepts for Review Autarky Dualism Average product False-paradigm model Capital-labor ratio Free market Capital-output ratio Free-market analysis Center Harrod-Domar growth model Closed economy Lewis two-sector model Comprador groups Marginal product Dependence Market failure Dominance Concepts for Review (cont’d) Market-friendly approach Production function Necessary condition Public-choice theory Neoclassical Self-sustaining growth counterrevolution Solow neoclassical growth model Neocolonial dependence Stages-of-growth model of model development Net savings ratio Structural-change theory New political economy Structural transformation approach Sufficient condition Open economy Surplus labor Patterns-of-development analysis Underdevelopment Periphery Appendix 3.1: Components of Economic Growth Capital Accumulation, investments in physical and human capital Increase capital stock Growth in population and labor force Technological progress Neutral, labor/capital-saving, labor/capital augmenting Figure A3.1.1 Effect of Increases in Physical and Human Resources on the Production Possibility Frontier Figure A3.1.2 Effect of Growth of Capital Stock and Land on the Production Possibility Frontier Figure A3.1.3 Effect of Technological Change in the Agricultural Sector on the Production Possibility Frontier Figure A3.1.4 Effect of Technological Change in the Industrial Sector on the Production Possibility Frontier Appendix 3.2 The Solow Neoclassical Growth Model Appendix 3.2 The Solow Neoclassical Growth Model Appendix 3.2 The Solow Neoclassical Growth Model Figure A3.2.1 Equilibrium in the Solow Growth Model Figure A3.2.2 The Long-Run Effect of Changing the Saving Rate in the Solow Model Appendix 3.3 Endogenous Growth Theory Motivation for the new growth theory The Romer model CHAPTER 4: Contemporary Models of Development and Underdevelopment Individuals need not make the right tradeoffs. And whereas in the past we thought the implication was that the economy would be slightly distorted, we now understand that the interaction of these slightly distorted behaviors may produce very large distortions. The consequence is that there may be multiple equilibria and that each may be inefficient. — Karla Hoff and Joseph E. Stiglitz, Frontiers in Development Economics, 2002 Governments can certainly deter entrepreneurship when they try to do too much; but they can also deter entrepreneurship when they do too little. — Dani Rodrik, One Economics, Many Recipes, 2007 Binding constraint The one limiting factor that if relaxed would be the item that accelerates growth (or that allows a larger amount of some other targeted outcome). Economic agent An economic actor—usually a firm, worker, consumer, or government official—that chooses actions so as to maximize an objective; often referred to as “agents.” Many newer theories of economic development that became influential in the 1990s and the early years of the twenty-first century have emphasized complementarities between several conditions necessary for successful development. These theories often highlight the problem that several things must work well enough, at the same time, to get sustainable development under way. They also stress that in many important situations, investments must be undertaken by many agents in order for the results to be profitable for any individual agent. Generally, when complementarities are present, an action taken by one firm, worker, or organization increases the incentives for other agents to take similar actions. Complementarity An action taken by one firm, worker, or organization that increases the incentives for other agents to take similar actions. Complementarities often involve investments whose return depends on other investments being made by other agents. Models of development that stress complementarities are related to some of the models used in the endogenous growth approach (described in Appendix 3.3), in ways we will point out later in the chapter, but the coordination failure approach has evolved relatively independently and offers some significant and distinct insights Coordination failure A situation in which the inability of agents to coordinate their behavior (choices) leads to an outcome (equilibrium) that leaves all agents worse off than in an alternative situation that is also an equilibrium. Put simply, a coordination failure is a state of affairs in which agents’ inability to coordinate their behavior (choices) leads to an outcome (equilibrium) that leaves all agents worse off than in an alternative situation that is also an equilibrium. This may occur even when all agents are fully informed about the preferred alternative equilibrium: They simply cannot get there because of difficulties of coordination, sometimes because people hold different expectations and sometimes because everyone is better off waiting for someone else to make the first move. This section spells out the meaning and implications of these perspectives in detail, through both simple models and examples When complementarities are present, an action taken by one firm, worker, organization, or government increases the incentives for other agents to take similar actions. In particular, these complementarities often involve investments whose return depends on other investments being made by other agents. In development economics, such network effects are common, and we consider some important examples later in this chapter, including the model of the big push, in which production decisions by modern-sector firms are mutually reinforcing, and the O-ring model, in which the value of upgrading skills or quality depends on similar upgrading by other agents. Big push A concerted, economy-wide, and typically public policy– led effort to initiate or accelerate economic development across a broad spectrum of new industries and skills. O-ring model An economic model in which production functions exhibit strong complementarities among inputs and which has broader implications for impediments to achieving economic development. Middle-income trap A condition in which an economy begins development to reach middle-income status but is chronically unable to progress to high-income status. Often related to low capacity for original innovation or for absorption of advanced technology, and may be compounded by high inequality Underdevelopment trap A poverty trap at the regional or national level in which underdevelopment tends to perpetuate itself over time. Deep intervention A government policy that can move the economy to a preferred equilibrium or even to a higher permanent rate of growth, which can then be self-sustaining so that the policy need no longer be enforced because the better equilibrium will then prevail without further intervention Congestion The opposite of a complementarity; an action taken by one agent that decreases the incentives for other agents to take similar actions. Whenever congestion may be present, these counterpressures are very strong: The more people there are fishing in one lake, the more fishers try to move to another lake that is less crowded; the more people there are using one road, the more commuters Deep intervention A government policy that can move the economy to a preferred equilibrium or even to a higher permanent rate of growth, which can then be self-sustaining so that the policy need no longer be enforced because the better equilibrium will then prevail without further intervention. Congestion The opposite of a complementarity; an action taken by one agent that decreases the incentives for other agents to take similar actions. Find more at http://www.downloadslide.com try to find an alternative route Where-to-meet dilemma A situation in which all parties would be better off cooperating than competing but lack information about how to do so. If cooperation can be achieved, there is no subsequent incentive to defect or cheat Prisoners’ dilemma A situation in which all parties would be better off cooperating than competing, but once cooperation has been achieved, each party would gain the most by cheating, provided that others stick to cooperative agreements—thus causing any agreement to unravel. Multiple equilibria A condition in which more than one equilibrium exists. These equilibria sometimes may be ranked, in the sense that one is preferred over another, but the unaided market will not move the economy to the preferred outcom Pareto improvement A situation in which one or more persons may be made better off without making anyone worse off. The classic example of this problem in economic development concerns coordinating investment decisions when the value (rate of return) of one investment depends on the presence or extent of other investments. All are better off with more investors or higher rates of investment, but the market may not get us there without the influence of certain types of government policy (but note that we may also not arrive at the preferred solutions if we have the wrong kinds of government policy). The difficulties of investment coordination give rise to various government-led strategies for industrialization that we consider both in this chapter and later in the text (see especially Chapter 12) 4.8 Conclusions The important point is not that people keep doing inefficient things. This is not in itself very surprising. The deeper point is that people keep doing ineffIcient things because it is rational to keep doing them, and it will remain ratio - nal as long as others keep doing inefficient things. This leads to a fundamental problem of coordination failure. Sometimes firms and other economic agents will be able to coordinate to achieve a better equilibrium on their own. But in many cases, government policy and aid will be necessary to overcome the resulting vicious circles of underdevelopment. The purpose of economic development theory is not only to understand underdevelopment but also to devise effective policies to redress it. The analysis of coordination failure problems in this chapter affirmed that early development theorists such as Paul Rosenstein-Rodan identified important potential problems that are ignored in conventional competitive equilibrium models.51 The new perspectives offer some important overall lessons for policy, but they are not simple lessons with easy applicability, and indeed they present some - thing of a two-edged sword. On one side, the analysis shows that the potential for market failure, especially as it affects the prospects for economic devel - opment, is broader and deeper than had been fully appreciated in the past. Rather than the small “deadweight triangle losses” of conventional economic analysis of monopoly, pollution externalities, and other market failures, coordination failure problems can have more far- reaching effects and consequently much greater costs.52 For example, the interactions of slightly distorted behaviors by potential investors failing to consider the income effects of the wages they pay may produce very large distortions, such as the outright failure to industrialize. This makes the potential benefit of an active role for government larger in the context of multiple equilibria OTHER SOURCE: Economic Development TWELFTH EDITION, by: Michael P. Todaro and Stephen C. Smith

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