chapter 3

Bannerjee and Iyer, "property rights institutions." Landlords versus cultivators

The regions in which property rights institutions were given to landlords have had significantly lower agricultural investments and productivity in the post- independence period than regions in which property rights were given to cultivators

Theory says that

Faster-growing developing countries would be catching up with the slower-growing developed countries. Since,

Economic Development needs

promoting free markets governments only to guide resource allocation

The growth rate of national income is

-positively related to the savings ratio and negatively related to the economy's capital output ratio. - In order to grow: economies must save and invest a certain proportion of their GDP

∆𝒀 /Y= 𝒔/𝒄

S= national saving Y= national income or output s= saving ratio K: capital stock C = capital-output ratio I = net investment,

What happens if there are exogenous changes in the Technology

That is A increases? Note: technological improvement/ progress and increase in (total factor) productivity are the same thing

3. Technological progress results from new and improved ways of accomplishing traditional tasks

- Neutral - When higher output levels are achieved with the same quantity and combinations of factor inputs. - Labor/capital-saving - When higher output levels are achieved with saving either labor or capital. Labor Saving; Computers, Modern Machinery; Capital Saving; back-mounted mechanical sprayers for small-scale farming. Labor/capital augmenting -Increasing productivity. Ex. Improving skills of the labor

5%=s/3 s=15% What happens if only save 10%? Either

- grow less fast (3.3%) or extra 5% of savings must come from elsewhere such as Foreign direct investment or Aid,

2. Growth in population and labor force

- A larger labor force means more productive workers, and a large overall population increases the potential size of domestic markets. - Growing supplies of workers in developing countries with a surplus of labor may exert a positive or a negative influence on economic progress. - Depends on the economic system to absorb and productively employ these added worker. - The production possibility curve portrays the maximum attainable output combinations of any two commodities. - In the LR , the improvement and upgrading of the quality of existing resources and new investments are principal means of accelerating the growth of national output

Introduction

- Each offers valuable insights and a useful perspective on the nature of the development process. - Each approach has its strengths and weaknesses - There exists controversy such as ideological, theoretical, or empirical

Development As Growth and Linear -Stages - Rostow's Stages of Growth

- In 1960 Walt Rostow wrote: The Stages of Economic Growth: An anti-communist manifesto. - It shaped the way many see development Idea of a linear progression progression and progress, like development are optimistic terms, implying an ordering towards better things - Partly description of societies at different stages, partly theory of transition between stages. - A country passes through sequential stages in achieving development. - One of the principal strategies of development necessary for any takeoff was the mobilization of domestic and foreign saving in order to generate sufficient investment to accelerate economic growth

1. Capital Accumulation, investments in physical and human capital

- Increase capital stock (Ex. New factories, machinery, equipment, and materials) - Productive investments are supplemented by investments in what is known as social and economic infrastructure (Ex. Roads, electricity, water and sanitation, communications)

The Harrod-Domar model suggests that the economy's rate of growth depends on

-The level of saving -The productivity of investment (i.e. the capital output ratio) -Emphasis on investment, savings and technology as the main agents of economic growth. -Increased investment would force the production possibility curve outwards and create more wealth

Classic Theories of Economic Development

4 Approaches

Long Term Economic Growth

A rise in real GDP (or GNI) per capita, The Solow Neoclassical Growth Model: A framework is developed to think about the causes and the process of economic growth and cross country differences. Solow framework allows to study sources of economic growth and gain an understanding of which country characteristics contribute to economic growth. The Solow growth shows how growth in the capital stock, growth in the labor force, and advances in technology affect a nation's total output of goods and services. Closed economies with low savings rates grow slowly in the SR and converge to lower per capita income levels. Open economies converge at higher levels of per capita income levels. Capital flows from rich to poor countries as K- L ratios are lower and investment returns are higher in the poor countries. Poor countries choose a low growth path by impeding the flow of foreign investment

Divergence

A tendency for per capita income to grow faster in higher income countries than in lower-income countries so that the income gap widens across countries over time

"antidevelopmental" economic growth

All the extra income and output growth are distributed to the few owners of capital, while income and employment levels for the masses of workers remain largely unchanged

Solow's model differs from Harrod-Domar model in the following respects

Allows for substitution between labor and capital Assumes that there exist diminishing returns to these inputs Introduces technology in the growth equation Solow's model of economic growth implies that economies will conditionally converge to the same level of income, given that they have the same rates of savings, depreciation, labor force growth, and productivity growth Technological progress became the main factor explaining long-term growth. Its level is determined exogenously

Criticisms and limitations Of The International-Dependence Revolution

Although they offer an appealing explanation of why many poor countries remain underdeveloped, they give no insight into how countries initiate and sustain development. The actual economic experience revolutionary campaigns of industrial nationalization and state-run production has been mostly negative. Policy of autarky mostly unsuccessful Ex. China and India, experienced stagnant growth and ultimately decided to open their economies

Criticisms of the Lewis Model

Assumptions do not fit the realities of contemporary developing countries Reality is that- Capitalist profits are invested in labor saving technology Existence of capital flight Little surplus labor in rural areas Growing prevalence of urban surplus labor Tendency for industrial sector wages to rise in the face of open unemployment 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

The Solow model emphasizes capital accumulation and changes in productivity

Capital accumulation alone cannot sustain growth A higher saving rate does not affect the long-run growth rate but raises the steady-state capital- labor ratio and thus output per worker Countries with the same technology, savings rate, and population growth rate Government policy, including regulation and taxation, can have important effects on capital accumulation and total factor productivity Economic growth (long-run increases in per capita output) requires continuous increases in productivity, which in turn stimulates growth of the capital-labor ratio, Policies that may affect productivity: Rule of Law"/ Effective governance and institutions Policies toward innovation (Patents, R&D incentives) Sound macroeconomic policies § Infrastructure Education and Health Openness

Acemoglu, Johnson, and Robinson's "reversal of fortune" and extractive institutions

Changes in the institutions resulting from European colonialism. The reversal of relative income among former colony countries that we observed today are primarily due to "European colonialism that led to the development of institutions of private property in previously poor areas, while introducing extractive institutions or maintaining existing extractive institutions in previously prosperous places. Among countries colonized by European powers during the past 500 years, those that were relatively rich in 1500 are now relatively poor. Ex. Latin America Europeans were more likely to introduce institutions encouraging investment in regions that were previously poor

What happens if there are exogenous changes in the savings rate (s)

Changing the saving rate in the solow model When savings rate, s (s`> s), curve sf(k) shifts upward to s`f(k). Equilibrium point shifts from k* to k*` Compared two steady states (k* vs k*`), we have a higher investment per worker (k=K/L) and a higher output (or income) per worker (y=Y/L) Other things equal, a higher savings rate results in a higher steady-state capital-labor ratio a higher steady-state output per worker

Chapter 3

Classic Theories of Economic Growth and Development

Empirical Patterns of Development

Demographic transition; population growth first increasing and then decreasing in the process of development, Differences in development among the countries are ascribed to: Domestic constraints, ex. Resource endowment, population International constraints, ex. International trade, technology, To summarize, structural-change analysts believe that the "correct mix" of economic policies will generate beneficial patterns of self-sustaining growth

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

Easy Technology transfer

Do not have to "reinvent the wheel" Advantage of Backwardness. Britain doubled its output per person in the first 60 years of its industrial development, and the South Korea <12 and China <9 years.

3. The International-Dependence Revolution

During the 1970s, international-dependence models gained increasing support, especially among developing-country intellectuals, Continues as anti-globalization movement: The IDR models reject the exclusive emphasis on GNP growth rate as the principal index of development Instead they place emphasis on international power balances and on fundamental reforms world-wide, IDR models view developing countries as beset by institutional, political, and economic rigidities in both domestic and international setup The IDR models argue that developing countries are up in a dependence and dominance relationship with rich countries

Also known as the two-sector surplus labor model It became the general theory of the development process in surplus-labor Third World nations during the 1960s and early 1970s. Features of the basic model

Economy consists of two sectors- traditional and modern Traditional sector has surplus of labor (MPL=0). This implies that labor can be removed from the agricultural sector without any loss of output in that sector. Constant Urban Wage-Perfectly elastic supply curve Model focuses on the process of transfer of surplus labor and the growth of output in the modern sector

Assumptions

Emphasizes the role of capital and productivity Population grows at rate n Physical capital depreciates at rate δ Closed economy Constant returns to scale. S=I Constant fraction of population is working Result of model= economic growth results only from continuous increases in productivity

The Neoclassical Counterrevolution

Endogenous Growth-Model-Romer Model Motivation for the new growth theory: Try to explain the engine of growth It is important to understand the economic forces underlying technological progress The contribution of this model is that it emphasizes the link between Technical innovation, Human Capital, and Institutions including Government

Schematic Representation

Geography Institutional quality-colonial and post-colonial Colonial legacy- pre colonial comparative advantage Evolution and timing of European development Inequality- human capital Type of colonial regime

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

Assume Cobb-Douglas Production Function

Here, everything is measured in quantities per worker. The more capital with which each worker has to work, the more output that worker can produce, Solow model assumptions: Production [f(k)] Households save a constant fraction of income S=sY Savings equals investment S=I ∆𝐾 = 𝐼 − 𝛿𝐾 Labor is growing at rate n ∆L/L = n

Convergence

Lower-income countries are "catching up" over time

4. The Neoclassical Counterrevolution

Market Fundamentalism: Four component approaches: Free-market analysis- markets alone are efficient Public-choice theory(New Political Economy)- governments can do nothing right Market- friendly approach- governments have a key role to play in facilitating operations of markets through nonselective(Market-friendly) interventions New institutionalism- success or failure of developmental efforts depend upon the nature, existence, and functioning of a country's fundamental institutions

Three important contributions

Market price allocation is usually more efficient than intervention. State-owned enterprises have not fulfilled their promise and have been inefficient. Incentives must be stressed. The neoclassical approach is criticized on the grounds that markets in developing countries, when they exist, are far from perfect and cannot be made perfect by any simple formula

Criticism of the Stage Model:

Necessary versus sufficient conditions Investment probably necessary for growth, but not sufficient, much left out such as institutions, skilled labor, structure of developing countries. Economic growth and economic development are not the same. Borrowing from overseas to fill the gap caused by insufficient savings causes debt repayment problems later,

If there were unconditional convergence, there should be a clear negative relationship, with the initially lower-income countries growing faster

No apparent tendency toward convergence across countries. About 60% of countries grew more slowly than the United States.

Linear stages of growth model

Rostow's Stage of Growth and The Harrod-Domar (AK) Mode

The neocolonial dependence model

Outgrowth of Marxist thinking. The existence and continuance of underdevelopment primarily to the historical evolution of a highly unequal international capitalist system of rich country-poor country relationships. Unequal power relationships between the center (the developed countries) and the periphery (the developing countries) renders attempts by poor nations to be self-reliant and independent difficult. Only certain elite groups within country benefits. NGOs, World Bank, IMF, MNCs work for the benefits of the system. Solution revolutionary struggle or restructuring of the World capitalist system

Empirical Patterns of Development

Patterns of development theorist: increased savings and investment as necessary but no sufficient for economic development In addition to capital accumulation, transformation of production, composition of demand, and changes in socio-economic factors are all important

The false-paradigm model

Pitfalls of using "expert" foreign advisors who Attributes under development to the faulty and inappropriate advice provided by well-meaning but biased and ethnocentric international "expert advisers" Education with Western concepts may not work for local policy-makers. The policy prescriptions serve the vested interests of existing power groups, both domestic and international

The Harrod-Domar Model

Saving is a proportion of national income: 𝐒 = 𝒔𝒀 (1) Net national saving must equal net investment: 𝐒=𝑰 (2) Net Investment (I) is change of Capital stock (K): 𝑰 = ∆𝑲 (3) The capital - output ratio is given by: 𝑲/Y = ∆𝑲/∆Y =𝒄 or∆𝑲=𝒄∆𝒀(4) GDP growth rate is given by: 𝑺=𝒔𝒀= 𝑰= ∆𝑲=𝒄∆𝒀 𝒔𝒀 = 𝒄∆𝒀

Chenery and colleagues identified several characteristic features of economic development

Shift from agriculture to industrial production Steady accumulation of physical and human capital Change in consumer demands from food to manufactured products Increased urbanization Decline in family size

Neoclassical, free market counterrevolution

Solow Growth Model and Endogenous(Romer) Growth Model

The concept embraces four key arguments

Superior and inferior conditions can coexist in a given space at given time. The coexistence is chronic and not transitional The degrees of the conditions have an inherent tendency to increase due to increasing of productivity gap. Superior conditions serve to "develop under development"

Impact of increase in savings rate

Temporary increase in per capital K/L and per capita output. However, both would return to a steady-state of growth at higher level of per capita output Savings has no impact on long-run per capita output growth rate but has an impact on long- run level of per capita output Countries with the same technology and savings rate will converge to the same capital per worker and output per worker ("conditional convergence")

Theories and Patterns of structural change

The Lewis Theory of Development and Patterns of Development

2. Structural-Change Models

The Lewis Two-Sector Model : Structural-change theory focuses on the mechanism by which underdeveloped economies transform their domestic economic structures from traditional to an industrial economy. Structural change theory focuses on how underdeveloped economies transform their economic structures. The transformation is from traditional subsistence agriculture to a modern urbanized industrialized economy. A traditional, overpopulated rural subsistence sector characterized by zero marginal labor productivity. A high productivity modern urban industrial sector into which labor from the subsistence sector is gradually transferred. Representative examples of this strand of thought are The Lewis theory of development Chenery's patterns of development

International-dependence Revolution

The Neocolonial Dependence Model, The False-Paradigm Model, The Dualistic-Development Thesis

Each theory has some strengths and some weaknesses

The linear-stages model emphasizes the crucial role that saving and investment play in promoting sustainable long-run growth. The Lewis two-sector model underlines the importance of transfers of resources from low-productivity to high-productivity activities in the process of economic development. The empirical research of Chenery identifies key economic parameters involved in the economic development process

One-Time Neoclassical Growth Model

When the economy is hit by an exogenous technology shock, both production function and savings curves shift upward. New steady state, where we have both a higher capital per worker and income per capita Increase of income per capita is a result of two changes: not only the upward-shifted sy curve, but also the upward-shifted y curve

Rapid capital accumulation

Through domestic resources and international investment.

The Harrod-Domar Model - Incorporating Capital Depreciation

We can include depreciation in the model in which case the growth rate is given by where δ is the rate of capital depreciation ΔY/Y = s/c - δ Savings is the way to grow: Low growth countries- Do not save enough (low s) Are not productive with their investments (high c=K/ Y) § Have high population growth (high g) Have high depreciation Such countries may need aid (which supplements low S) to avoid declining,

Nature and Role Of Economic Institution

Work in progress. Institutions provide "rules of the game" of economic life: Provide support for market economy; Include property rights; contract enforcement Can work for improving coordination; Providing access to opportunities for the broad population Constraining the power of elites, and managing conflict Provision of predictable macroeconomic stability

What happens if there are exogenous changes in the population growth rate (n) Other things equal, a higher n results in

a lower steady-state capital-labor ratio a lower steady-state output per worker The model predicts that economies with higher rates of population growth will have lower levels of capital per worker and lower levels of income

Three streams of thought

a. Neoclassical dependence model b. False-paradigm model c. Dualistic-development thesis

International-dependence theorists

alert us to the importance of the structure and workings of the world economy and the many ways in which decisions made in the developed world can affect the lives of millions of people in the developing world

The central argument of the neoclassical counterrevolution underdevelopment results from poor resource allocation

due to incorrect pricing policies too much state intervention overly active developing-nation governments

Neoclassical counterrevolution in the 1980s

freer markets, decreasing of public ownership, Elimination of government regulations

Results in the following changes in the steady-state

higher savings per capita (not: higher savings rate!) a higher capital-labor ratio (k*) a higher per capita output (y*)

Dualistic approach focuses

on the role of ruling elites in the domestic economies of the developing world

Neoclassical economic theory

predicts that the efficient production and distribution through a proper, functioning price system is an integral part of an successful development process

The dualistic-development thesis

represents the existence and persistence of increasing divergences between rich and poor nations and rich and poor peoples at all levels. Prebisch-Singer Hypothesis suggests that over the long run the price of primary goods such as coal, coffee cocoa declines in proportion to manufactured goods such as cars, washing machines and computers

Example

want to grow at 5% per year ΔY/Y = 5% so if c = K/Y = 3 How much do needs to be saved? ΔY/Y = s/c

By definition, net change of capital ∆𝐾 equals Investment (I) minus capital depreciation 𝛿𝐾, thus ∆𝐾 = 𝐼 − 𝛿𝐾 (1) Since all savings eventually finds its way to investment

we have 𝑆 = 𝐼 , and assume savings is a fixed proportion of income, we have 𝑆 = 𝑠𝑌 Plug these two equations into equation (1), we get: ∆𝐾=𝐼−𝛿𝐾=𝑠𝑌−𝛿𝐾 (2) ∆𝐾=𝑠𝑌−𝛿𝐾 divide by L and get ∆K/L =𝑠𝑦−𝛿𝑘 (3) Given that ∆𝐾=∆𝑘𝐿+∆𝐿𝑘 𝑎𝑛𝑑 ∆L/L =𝑛 plug into(3) [∆kL+∆Lk]/L =𝑠𝑦−𝛿𝑘 ∆𝑘+𝑛𝑘=𝑠𝑦−𝛿𝑘 and∆𝑘=𝑠𝑦−𝛿𝑘−𝑛𝑘=𝑠𝑦 −(𝛿+𝑛)𝑘 plug y=f(k) Final equation is ∆𝑘 = 𝑠𝑓(𝑘) − (𝛿 + 𝑛)𝑘 (4)

The Solow Neoclassical Growth Model

∆𝑘 = 𝑠𝑓(𝑘) − (𝛿 + 𝑛)𝑘 Per capita capital stock is affect by investment, depreciation, and population growth The steady state value of capital k that maximizes consumption is called the Golden Rule level of capital. In the steady state, where savings investment equals investment required by population growth and depreciation

Equating 1-4; GDP growth rate is given by

𝑺=𝒔𝒀= 𝑰= ∆𝑲=𝒄∆𝒀 𝒔𝒀 = 𝒄∆𝒀,