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Economics of Development: Theory and Evidence Tenth edition A.P. Thirlwall and Penélope Pacheco-López  Economics of Development Chapter 1. Study of Economic Development Development economics as a subject Academic interest in deve...

Economics of Development: Theory and Evidence Tenth edition A.P. Thirlwall and Penélope Pacheco-López  Economics of Development Chapter 1. Study of Economic Development Development economics as a subject Academic interest in development New empirical development economics New international economic order Sustainable Development Goals Globalisation and interdependence of world economy Meaning of development and challenge of development economics Perpetuation of underdevelopment 2  Economics of Development Development Economics as a Subject Started after World War II because of: – Renewed interest in growth and development theory – Poor countries increasingly aware of own backwardness – Humanitarian interest in reducing poverty – Growing recognition of interdependence of world economy Concerned with why some countries rich, others poor; why countries grow at different rates, and how to reduce poverty. 3  Economics of Development Academic Interest in Development Classical economists e.g. Smith, Malthus, Ricardo, Mill, Marx, all concerned with progress of nations. In neoclassical era, little interest in growth and development theory. Interest revived with Harrod’s famous paper ‘An Essay in Dynamic Theory’ (Economic Journal, 1939). Since 1945, some of world’s top economists have focussed on development economics e.g. Paul Collier; Partha Dasgupta; Angus Deaton; Albert Hirschman; Nicholas Kaldor; Simon Kuznets; Harvey Leibenstein; Arthur Lewis; James Mirrlees; Gunnar Myrdal; Joan Robinson; Dani Rodrik; Amartya Sen; Hans Singer, Joseph Stiglitz. 4  Economics Economicsof ofDevelopment Development Development economics has pioneered following concepts : – Low-level equilibrium trap – Models of population and growth – ‘Big push’ theory – Models of rural-urban migration – Dynamic externalities – Immisering growth – Models of dualism – Models of structural inflation – Theory of circular and cumulative causation – Dual gap analysis – Dependency theory – Theory of missing markets – Growth pole analysis – Rent-seeking behaviour 5  Economics of Development New Empirical Development Economics In recent years development economics has seen an outpouring of empirical studies Micro-empirics tests theoretical hypotheses about decision-making and economic behaviour at the household level (e.g. randomised control trials) Macro-empirics tests causal relations between macro-variables (e.g. causes of growth) Some argue that there is too much empirics and not enough theory Both theory and empirics are required for purposes of prediction and policy evaluation 6  Economics of Development New International Economic Order (NIEO) Seeks to provide fairer deal for poor countries in world economy. – Improved terms of trade for exports of poor countries – Greater access to markets of developed countries – More aid and debt relief – Greater say in decision-making of international institutions e.g. IMF, World Bank, WTO – International food programme – Greater technical cooperation World is strong on rhetoric; weak on action. 7  Economics of Development Sustainable Development Goals (SDGs) 169 targets grouped into 17 goals. SGDs replaced Millennium Development Goals set in 2000 SDGs set in 2015 to be achieved by 2030: 1. End poverty in all its forms everywhere 2. End hunger, achieve food security and improved nutrition and promote sustainable agriculture 3. Ensure healthy lives and promote well-being for all at all ages 4. Ensure inclusive and equitable quality education and promote lifelong learning opportunities for all 5. Achieve gender equality and empower all women and girls 6. Ensure availability and sustainable management of water and 8 sanitation for all  Economics of Development Sustainable Development Goals (cont.) 7. Ensure access to affordable, reliable, sustainable and modern energy for all 8. Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all 9. Build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation 10. Reduce inequality within and among countries 11. Make cities and human settlements inclusive, safe, resilient and sustainable 12. Ensure sustainable consumption and production patterns 13. Take urgent action to combat climate change and its impacts 9  Economics of Development Sustainable Development Goals (cont.) 14. Conserve and sustainably use the oceans, seas and marine resources for sustainable development 15. Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss 16. Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels 17. Strengthen the means of implementation and revitalize the global partnership for sustainable development 10  Economics of Development Globalisation and Interdependence of World Economy Definition of globalisation: ‘ongoing process of greater economic interdependence among countries reflected in increasing amount of cross-border trade in goods and services, increasing volume of international financial flows and increasing flows of labour’ (Fischer, 2003) Characteristics of globalisation: – Massive capital flows: long term, speculative short-term, and foreign direct investment – Outsourcing of production to other countries – Labour migration – Spread of information technology – New institutions with authority over national governments 11 – Spread of disease, crime , flow of arms (public ‘bads’)  Economics of Development Challenge of globalisation is to preserve advantages of global markets, but tempered by: – Ethics –less violation of human rights – Equity –less income disparity within and between nations – Inclusion –less marginalisation of people and countries – Human security –less instability of countries and vulnerability of people – Sustainability –less environmental destruction – Development –less poverty and deprivation 12  Economics of Development Meaning of Development and Challenge of Development Economics Denis Goulet distinguished three core components of development: life sustenance, self-esteem and freedom 1. Life sustenance is provision of basic needs: housing; food; clothing; education; health 2. Self esteem is feeling of self respect and independence 3. Freedom means freedom to chose, so people can determine own destiny. Development expands range of human choice open to individuals and society 13  Economics of Development Amartya Sen defines development as expansion of people’s entitlements and capabilities; the former giving life sustenance; the latter giving freedom Major categories of ‘unfreedom’ include famine and malnourishment; poor health; lack of basic needs; lack of political liberty, and civil rights; economic insecurity Aggregate measures of growth not always a good measure of expansion of entitlements and capabilities of people 14  Economics of Development Perpetuation of Underdevelopment Many factors perpetuate poverty and underdevelopment: – Backwardness of agriculture – Risk-averse nature of poor people in agriculture – Low saving due to low income, leading to low savings –a classic vicious circle – Rapid population growth – Structure of production: poor countries specialising in primary commodities – Structure of trade: poor countries exporting primary commodities and importing manufactures – Debt – Terms of trade deterioration of primary commodities and of poor countries – Protection by developed countries Divisions in world economy will persist without tackling these issues 15  Economics of Development Learning Objectives You should now know: – Origins of development economics – What the subject is all about – Concepts that development economists/economics have invented – Components of a new international economic order (NIEO) – Sustainable Development Goals (SDGs) – Meaning of globalisation and interdependence of world economy – Challenges of globalisation – Meaning of development: ideas of Goulet and Sen – Challenges of development economics – Forces that perpetuate underdevelopment 16  Economics of Development Chapter Summary Modern development economics originated after World War II Development economics concerned with divisions in world economy between rich and poor and why countries grow at different rates Poor countries need fairer deal in world economy to develop more rapidly Development means providing basic needs and expanding entitlements and capabilities of people Sustainable Development Goals have been set for 2030 Globalisation presents opportunities and challenges Many poor countries caught in vicious circles of poverty. Challenge of development policy is to break these vicious circles 17  Economics of Development Websites Institutes of development studies Institute of Development Studies, University of Sussex www.ids.ac.uk School of Development Studies, University of East Anglia http://www.uea.ac.uk/international-development/ Globalization Centre for Research on Globalization http://www.globalresearch.ca Peterson Institute for International Economics http://piie.com New Economics Foundation www.neweconomics.org International organizations World Bank www.worldbank.org International Monetary Fund www.imf.org 18  Economics of Development Websites (cont.) International organizations United Nations Conference on Trade and Development (UNCTAD) www.unctad.org United Nations Development Programme (UNDP) www.undp.org Food and Agricultural Organization (FAO) www.fao.org World Trade Organization (WTO) www.wto.org World Health Organization (WHO) www.who.int United Nations Industrial Development Organization (UNIDO) www.unido.org International Labour Organization (ILO) http://www.ilo.org African Development Bank www.afdb.org Asian Development Bank www.adb.org Inter-American Development Bank www.iadb.org Centre for Global Development (Washington) www.cgdev.org Non-Governmental Organizations Global Network www.ngo.org Heritage Foundation www.heritage.org Sustainable Development Goals https://sustainabledevelopment.un.org/sdgs 19 www.un.org/sustainabledevelopment/sustainable-development-goals/  Economics of Development Websites (cont.) Databases Penn World Tables 8.1 https://knoema.com/PWT2015/penn-world-table-8-1 World Bank http://data.worldbank.org/ World Bank, World Development Indicators http://data.worldbank.org/data-catalog/world- development-indicators International Monetary Fund http://data.imf.org/ Gapminder www.gapminder.org/ World Health Organization, Global Health Observatory www.who.int/gho/en/ UN Comtrade http://comtrade.un.org UNIDO https://stat.unido.org WIDER www.wider.unu.edu/project/wiid-%E2%80%93-world-income-inequality-database 20  Economics of Development Chapter 2. Development Gap and Measurement of Poverty Development gap and income distribution in world economy Measures of inequality and historical trends International inequality and Global (or world) inequality Measurement and comparability of per capita incomes at purchasing power parity (PPP) Per capita income as measure of development Measuring poverty Meeting Sustainable Development Goal poverty reduction target Tackling poverty from the ‘grass roots’ Randomised control trials Human Development Index Multidimensional poverty index Can poor countries ever catch up? 1  Economics of Development Development Gap and Income Distribution in World Economy Many concepts of development gap: Between ‘North’ and ‘South’ Between continents Between low, middle and high income countries as defined by the World Bank Many measures of development gap: Absolute income gap Relative income gap Variance and standard deviation of per capita incomes Gini ratio derived from Lorenz Curve All measures show historical rise in development gap over time 2  Economics of Development Measures of Inequality and Historical Trends Absolute gap measures gap between the richest and poorest countries. This gap widens through time Relative gap in ratio of richest country (or group of countries) to poorest country (or countries). This gap has widened through time. Ratio of per capita income in high income countries to low income countries now 60:1 Variance or standard deviation of per capita income measures dispersion around the mean. Necessary condition for dispersion to narrow is poor countries grow faster than rich countries (sigma convergence). No evidence of sigma convergence across all countries Gini ratio measures a country’s share of income in relation to share of population. Ratio varies between 0 and 1. 0 is perfect equality and 1 is perfect inequality (see Table 2.3) 3  Economics of Development Table 2.3 A comparison of Gino Ratios International Inequality Global (or World) inequality Year Bourguignon and Unweighted Population weighted Milanovic (2005 and 2016) Sala-i-Martin (2002) Morrisson (2002) 1820 0.20 0.12 0.50 1870 0.29 0.26 0.56 1890 0.31 0.30 0.59 1913 0.37 0.37 0.61 1929 0.35 0.40 0.62 1938 0.35 0.40 1952 0.45 0.57 0.64 1960 0.46 0.55 0.64 1978 0.47 0.54 0.66 0.66 (1970) 1988 0.53 0.60 0.68 0.65 1993 0.56 0.59 0.70 0.66 (1992) 0.64 1998 0.56 0.57 0.69 0.63 2002 0.58 0.56 0.71 0.63 2005 0.57 0.54 0.70 2008 0.55 0.51 0.69 2011 0.54 0.48 0.67 2013 0.54 0.47 Sources: Adapted from Milanovic, 2005, Table 11.1; Milanovic, 2016. 4  Economics of Development International and Global Inequality Three measures of inequality using Gini ratio: International inequality with each country given equal weight International inequality with each country weighted by population size Global (or world) inequality which takes individual person (or household) as unit of measurement; therefore takes account of inequality within countries as well as between countries In 19th century, international inequality relative to global inequality much less than today. In 1820, Gini for international inequality 0.2, and for global inequality 0.5. Today, Gini for international inequality 0.54; for global inequality 0.67 Major cause of global inequality today is inequality between, not within, countries. 5  Economics of Development Measurement and Comparability of Per Capita Incomes at Purchasing Power Parity (PPP) Difficult to measure and compare per capita income in poor countries for three reasons: – Practical difficulty of measuring money national income in rural economies – Only goods produced and sold in markets are included; not subsistence production – To compare countries’ per capita incomes, all values need conversion into common currency (e.g. US dollar), but official exchange rate only reflects supply and demand for traded goods Many goods are not traded (e.g. restaurant meals, haircuts, etc.) and their relative price is lower, the poorer the country To compare living standards, PPP rates of exchange necessary On average, poor countries’ per capita incomes at PPP are twice as high as measured by the official exchange rate 6  Economics of Development Per Capita Income (PCY) as Measure of Development Development means more than rise in PCY because it ignores distribution of income and human development. But PCY correlates with several characteristics of underdevelopment: – High proportion of labour force in low productivity agriculture – High proportion of expenditure on food and necessities – Low levels of savings and investment – Low level of technology, and poor human capital – Exports dominated by primary commodities PCY can be used as starting point for classifying levels of development, and identifies need for development. 7  Economics of Development Measuring Poverty Headcount Index counts number of people living below poverty line defined by the World Bank as $1.90 a day at PPP, currently 900 million. Poverty rate is ratio of poor people to total population (see Table 2.4) Poverty Gap measures the proportionate gap between the average level of PCY below the poverty line and the poverty line itself (see Table 2.5) e.g. if poverty line is $1.90 a day and average income below poverty line is $1.50, then poverty gap is ($1.90-$1.50)/($1.90) = 21% Food Energy Method measures number of people without sufficient income to buy minimum food intake. Income level to buy sufficient food will vary from country to country 8  Economics of Development Table 2.4 Absolute poverty and poverty rates, 1990 and 2012 Global and regional poverty at the poverty line of $1.90 per day (at 2011 PPP) Number of Poor in Millions Poverty rate (percent of population) Region 1990 2012 1990 2012 East Asia and Pacific 996 147 60.6 7.2 Europe and Central Asia 9 10 1.9 2.1 Latin America and the Caribbean 78 34 17.8 5.6 Middle East and North Africa 14 6.0 South Asia 575 309 50.6 18.8 Sub-Saharan Africa 288 389 56.8 42.7 World 1,959 897 37.1 12.7 Source: World Bank, 2015. 9  Economics of Development Table 2.5 Poverty gap at $1.90 a day (2011 PPP) (%) 2012 East Asia and Pacific (developing only) 1.47 Europe and Central Asia (developing only) 0.58 Latin America and Caribbean (developing only) 2.64 Low income 18.6 Lower middle income 4.69 Low and middle income 4.35 Middle East and North Africa (developing only) Sub-Saharan Africa (developing only) 16.47 10  Economics of Development Meeting the Sustainable Development Poverty Reduction Target Meeting Sustainable Development Poverty Reduction Target of eliminating extreme poverty by 2030, currently measured as people living on less than $1.90 a day at PPP The growth rate to meet the Target depends on the initial poverty rate and elasticity of poverty rate with respect to growth 11  Economics of Development Tackling Poverty from ‘Grass Roots’ World Bank approach: Promoting opportunity by expanding asset base of poor people and increasing return on assets. Facilitating empowerment by strengthening participation of poor people in decision-making; eliminating discrimination, and making State institutions more accountable. Enhancing security by providing insurance against economic shocks; natural disasters; crop failures; ill health; violence, and wars. 12  Economics of Development Randomised Control Trials (RCTs) RCTs used to find out the most effective way to fight poverty at the micro-level First a random group of people chosen to conduct experiments and then compare results with a control group not subject to experiment and see whether experiment leads to significant change in behaviour or outcome e.g. does micro- credit work; do financial incentives work to get children educated; etc. RCTs have limits: may be difficult to generalise results; experiment may be implemented in such a way that it cannot be replicated; trial itself may cause treatment and control group to alter behaviour, leading to false inferences 13  Economics of Development Human Development Index (HDI) HDI based on three variables: – Life expectancy at birth – Educational attainment measured as arithmetic mean of average and expected years of schooling – Per capita income at PPP Minimum and maximum value is given to each variable and index is constructed as: Index = (Actual value – Minimum value) / (Maximum value – Minimum value) Each index ranges from zero to one. If actual value = minimum value, index = 0. If actual value = maximum value, index = 1 HDI is an average of the three indexes and published by UNDP’s Human Development Report (see Case Example 2.3) 14  Economics of Development Multidimensional Poverty Index (MPI) Index developed by Oxford Poverty and Human Development Institute and published in UNDP’s Human Development Report Three main dimensions of poverty identified: education, health and standard of living. Each dimension has various indicators. Education measured by years of schooling and child attendance. Health Measured by child mortality and nutrition. Living standards measured by electricity, sanitation, drinking water, flooring, cooking fuel and asset ownership Each indicator has weights Person identified poor if deprived of at least one-third of weighted indexes About 800 million people are multidimensionally poor MPI does not take account of income-gap only consequences of lack of income 15  Economics of Development Can Poor Countries Ever Catch Up? Catch-up with rich countries requires per capita growth of poor countries in excess of rich countries. For poor country with annual per capita income of $1,200 growing at 4%, with rich country with PCY of $25,000 growing at 3%, catch up would take 300 years. For average poor country to reach current living standards of rich countries would take 150 years growing at 2 per cent per annum. 16  Economics of Development Learning Objectives You should now know: Measures of income inequality and development gap Difference between international and global inequality Concept of purchasing power parity (PPP) for comparison of real living standards across countries Use of per capita income as index of development Different ways of measuring poverty and extent of world poverty Use of Randomised Control Trials (RCTs) World Bank’s approach to tackling poverty How Human Development and Multidimensional Poverty Indices are constructed How to calculate whether poor countries will ever catch up with rich countries 17  Economics of Development Chapter Summary Absolute and relative income gaps between rich and poor countries are growing Gini ratio of international and global inequality has risen over last 100 years Number of people living in absolute poverty on less than $1.90 a day is 900 million PCY not always a good indicator of economic development, but correlated with characteristics of underdevelopment and identifies need for development HDI and Multidimensional Poverty Index give broader measures of development World Bank tackles poverty by promoting opportunities, facilitating empowerment and enhancing security For average poor country to reach average living standards of today’s rich could take 150 years. 18  Economics of Development Websites on Poverty and Income Distribution World Bank http www.worldbank.org/en/topic/poverty UNDP (Human Development Report) http://hdr.undp.org Oxford Poverty and Human Development Initiative www.ophi.org.uk/ Oxfam www.oxfam.org.uk War on Want www.waronwant.org WIDER www.wider.unu.edu/project/wiid-%E2%80%93-world-income-inequality- database Luxemburg Income Study Center www.gc.cuny.edu/liscenter University of Texas, Inequality Project http://utip.lbj.utexas.edu 19  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  Economics of Development Chapter 4. Theories of Economic Growth: Old and New Classical growth theory Harrod-Domar growth model Neoclassical growth model Production function approach to analysis of growth and studies for developing countries ‘New’ (endogenous) growth theory and macrodeterminants of growth ‘Growth diagnostics’ and binding constraints on growth 1  Economics of Development Classical Growth Theory All great classical economists concerned with economic growth and development: Adam Smith; David Ricardo; Thomas Malthus; John Stuart Mill; Karl Marx Smith optimistic about growth based on division of labour (specialisation) and increasing returns in industry, but division of labour limited by extent of the market Malthus, Ricardo, Mill pessimistic because diminishing returns in agriculture would cause famine, a rising price of food and decline in the profit rate on capital Marx predicted breakdown of capitalism itself because of falling rate of profit; immiseration of workers and a ‘realization’ crisis 2  Economics of Development Harrod-Domar Growth Model Modern growth theory started with Roy Harrod in 1939. Domar derived same results (independently) 1946 Harrod specifies three growth rates which may only equal each other by chance: actual growth rate (g); warranted equilibrium growth rate (gw); natural growth rate (gn) determined by labour force growth and technical progress –exogenously determined If g ≠ gw, cyclical fluctuations occur If gw ≠ gn, secular stagnation if gw > gn; structural unemployment and inflation if gn > gw Most developing countries have labour and technical progress growing faster than capital accumulation i.e. gn > gw –hence growing unemployment of structural variety 3 Nothing in Harrod model to equalize g, gw and gn  Economics of Development Neoclassical Growth Model Neoclassical growth model of Solow 1956 (also Swan 1956) challenged pessimistic conclusion of Harrod that no mechanism exists to equilibrate gw and gn Neoclassical model predicts economies will converge in the long run on natural rate of growth through capital-labour substitution. – If capital grows faster than labour (gw > gn), more capital intensive technologies used reducing gw by raising required incremental capital-output ratio – If labour grows faster than capital (gn > gw) more labour intensive techniques used raising gw by reducing required incremental capital-output ratio Neoclassical model also predicts convergence of per capita incomes across countries because poor countries with little capital will have higher marginal product of capital and therefore grow faster than rich countries –the assumption of diminishing returns to capital– given same tastes, preferences and 4 technology  Economics of Development Production Function Approach to Analysis of Growth and Studies for Developing Countries Neoclassical production function makes aggregate output a function of labour and capital inputs and technical progress If elasticities of output with respect to labour and capital are known, contribution of labour and capital input to measured growth can be estimated leaving technical progress as a residual Early studies applying production function to developed countries found technical progress most important factor explaining growth Studies for developing countries find capital input most important factor, not technical progress, so no growth ‘miracle’ in fast growing countries Production function very versatile because any growth –inducing variable can be added and its elasticity and rate of return measured e.g. education; R +D 5  Economics of Development ‘New’ (Endogenous) Growth Theory and Macrodeterminants of Growth ‘New’ (endogenous) growth theory formalised in 1980s as challenge to neoclassical assumption of diminishing returns to capital and that countries’ living standards will converge No evidence of convergence in world economy (see Chapter 2) because forces at work to keep marginal product of capital from falling in rich countries Human capital (education) and research and development (R+D) are key factors Empirical research shows there could be conditional convergence if only levels of education and other factors were same across rich and poor countries, but they are not Conditional convergence also consistent with idea of ‘catch up’ and faster structural change in poor than rich countries. 6  Economics of Development ‘Growth Diagnostics’ and Binding Constraints on Growth Studies across countries of macrodeterminants of growth cannot explain experience of individual countries Often country growth very volatile: fast and slow growth doesn’t persist over time ‘Growth diagnostics’ attempts to explain why growth is slow (or fast) in particular countries, and what are binding constraints If investment low, is it due to lack of finance; high cost of finance; low return to investment; or return cannot be appropriated by private agents? Different scenarios require different policies to relieve binding constraints World Bank Commission on Growth and Development finds sustained growth of successful countries most associated with: high savings and investment rates; fast export growth; macroeconomic stability; impact of knowledge and technology, and market-friendly policies 7  Economics of Development Learning Objectives You should now know: Views of classical economists Growth model of Harrod (and Domar) Assumptions and predictions of Solow neoclassical growth model Use of production function for understanding sources of growth Empirical studies using production function Origins and arguments of ‘new’ (endogenous) growth theory Meaning of ‘growth diagnostics’ and binding constraints on growth Characteristics of successful developing economies 8  Economics of Development Summary All great classical economists concerned with growth and development; Smith optimistic; others pessimistic Growth and development theory lay dormant until Harrod’s1939 contribution Solow’s neoclassical growth model tries to show there can be long run equilibrium growth, but assumptions and predictions of model are suspect Neoclassical production function can be used to analyse sources of growth, but factor supplies treated as exogenous Production function studies of developed and developing countries show technical progress most important in developed countries but factor inputs (particularly capital) in developing countries ‘New’ (endogenous) growth theory addresses why living standards across countries not converging. Answer is non-diminishing returns to capital because of human capital formation and endogenous technical progress ‘New’ growth theory studies cannot explain experience of individual countries. ‘Growth 9 diagnostics’ required to identify binding constraints on growth  Economics of Development Websites New School for Social Research (New York) http://www.newschool.edu/nssr/ Economic Growth Resources run by Jon Temple, Bristol University, UK www.bristol.ac.uk/efm/people/jon-r-temple/overview.html Overseas Development Institute www.odi.org Foundation for Advanced Studies on International Development www.fasid.or.jp/english Institute of Developing Economies Japan-External Trade Organization www.ide.go.jp/English/index.html The Vienna Institute for International Economic Studies www.wiiw.ac.at Carnegie Endowment for International Peace http://carnegieendowment.org/ 10