Dev. Econ Exam 1: Terms

Approaches to Development

- a complex and multi-dimensional process that can be understood by combining the understanding of economics, empirical analysis, and institutions and politics as well as culture vs: - a process about peopleinvolving mobilization of inputs, the role of trade, sectors including the role of government in human development. It is multi-disciplinary.

Ethiopia

-A case of poor (populous) country -Rely on self production of most of its consumption goods -PCI in 2004 roughly the same as it was in 1981 -Drought (famine), war, poor policy -Life expectancy 56 -Agriculture's share of GDP (51% 2011) (61% in 1961%) -Role of policy, technology, international relations (trade)

Ukraine

-Educated work force , basic needs met -Public provision of health care -Became independent in 1991 •Cost - benefit of independence -Life expectancy (64 in 2009 down from 66 in 1989), PCI in 1998 only 40% of what it was in 1989 -Health care system fell apart •Parallel markets (medicine) -Could not attract FDI •Backward technology •Poor quality products •Corruption

How the patterns of economic growth have changed since 1950

-Gap between western offshoots and W. Europe narrowed -Poorest region in 1950 (Asia) recorded the highest growth since (3.6%) -L. America stagnated in the 1980s and 90s -E. Europe collapsed -Africa's growth faded in 80s and 90s - Income GAP between rich & poor nations have grown. In 1820 the ratio of the average income of the richest regions to the poorest regions was 2:1; in 1950, it was 13:1 & in 2000, it was 19:1

Malaysia

-Macro issue (high unemployment) Vs. Micro (a girl's story) _ Government policy (encouraging export processing zones) -Role of infrastructure, language -Transformation of economy (especially the export structure) ,labor intensive manufacturing, share of agriculture down to < 10% - Average income quadrupled between 1970 and 2010 -Infant mortality (from 41/1000 to 6/1000) -Life Expectancy from 61 to 75, adult literacy (from 58% to 92%

•Major difference at the steady state

-Output per effective worker is constant -Output per actual worker increases at rate ѳ - Total out put grows at rate ѳ + n -With the introduction of technology, the model shows sustained growth in PCI at rate ѳ

Main sources of growth in different countries

-Sources of growth analysis suggest that capital accumulation is the main source of growth in developing countries. -TFP can play an important part in the growth process in the appropriate policy and structural context. -In rapidly growing economies, both play an important role. -TFP becomes more important as income rises and in high income industrialized countries.

growth depends on

1. Accumulation of factors (K, L, land) 2. Increasing productivity of these assets 3. S and I

Characteristics of Rapidly Growing Countries

1. Macroeconomic stability 2. Investment in Health and Education 3. Effective Governance and Institutions 4. Favorable Environment for Private Enterprise 5. Trade Openness 6. Favorable Geography or locatio

Different types of institutions that influence growth and development

1. market creating institutions 2. Market regulating institutions 3. Market stabilizing institutions 4. Market legitimizing institutions 5.Political institutions

Factors of Economic Growth

2 main factors: Factor Accumulation & Productivity Growth: Many factors that are important to growth: the amount and type of I, education and health care systems, natural resources, quality of institutions... At the core of most economic growth theories: the relationship between (L, K) and Q. New investment increases the capital stock Investment (I) is financed through savings (S) I=f(S) Savings comes from income/GDP S= f(GDP) These decisions are made by consumers, firms corporations, & governments Sustaining Growth requires both generating new investment and making sure it is productive & employment creating.

Economic Growth

A rise in national or per capita income

Divergent Patterns of Economic Growth since 1960

After 1960s LDCs began to diverge For example per capital income in Thailand was $960 and that of Zambia was $1,800 (in constant 2005 ppp) Thailand now has per capita income of $7,800, but Zambia is about $1,765? What happened? Growth difference: Thailand grew over 4.5% and Zambia's growth was negative (1765 is 2% lower than 1800).

The Effect of Changes in Saving Rate and Population Growth in the Solow Model

An increase in the S in the Solow Model will cause k to increase An increase in n will drop k

Capital widening

An increase in the capital stock that just keeps pace with the expanding labor force and depreciation.

global inequality

Becomes more important as the world becomes more integrated because of: -Much greater movement of factors of production -Greater influence of other people's (foreigner's ) standard of living and way of life on one's perceived income position and aspirations.

Why is Botswana Successful?

Between 1970-90, Botswana was the fastest growing country in the world at about 8% per year. But at independence in 1965, it was poor it had 100 high school graduates and 22 college graduates. What is the main source of success: Good policies and strong institution and democratic government Protection of property rights and minimal corruption including civil service base on merit not on patronage These has led to highest per capital income and best HDI Recent challenge: High HIV/AIDS infection rate has reversed this.

Lorenz Curve

Data from size distribution can be used to draw it Income recipients are arranged from lowest to highest income along the horizontal axis. The curve itself shows the share of total income received by any cumulative percentage of recipients.

Terminology for the different stages of country level of development based on Income

Developed vs developing or less developed (LDCs)= Low income Countries(LICs) lower middle income (LMIC), upper middle income (UMIC), high income (HIC), newly industrialized or OECD countries, third world, North vs South. •Low Income: GNI< = $1,045 (in 2020) •Lower Middle Income: 1,046 < = GNI < = 4,095 •Upper Middle Income: 4,096 < = GNI < = 12,695 High Income > = 12,696

Solow Model Equations

Divide Y=F (K,L) by L to express all variables in per-worker terms Y/L=F(K/L,1) y=f(k) Since ΔK =sY-dK: Δk=sy-(n+d)k Δk is determined by: s, -nk, and -dk Thus: S (and I) adds to K-per-worker, while L growth and depreciation reduce K-per-worker When sy>(n+d)k then k is increasing

Effective Governance and Institutions

Douglas North heavily influenced this area of study Many found a positive relationship between economic growth, the rule of law, extent of corruption , property rights and quality of government bureaucracy, and other measures of institutional quality Economic Growth = F( Institutions...) Other factors: effective private sector, civil society groups, and free press, political competition, etc..

Human Development Index (HDI)

Essential determinates of human development: -To live long and healthy life -Acquire knowledge -Have access to resources for a decent standard of living. -An index of health, knowledge and income: - Based on 3 indexes on Life expectancy, education & GDP or income per capita -All 3 dimensions expressed in percentages -Since 2010, UNDP uses geometric mean as opposed to arithmetic mean. - A better or more comprehensive measure than GDP per capita. - Ranges from 0 to 100% or (0 to 1) - The higher it is, the better the development Some criticisms: - Three indexes is too limited: we need other measures such as the Gender Gap - Assumes diminishing returns to income (only)

Variables contributing to growth

GDP/GNP (income); physical capital (K); human capital (H); political stability; education; institutions; type of economic system; geography; government type; investment and savings; imports and exports; trade; FDI; etc.

GDP per capita

GDP/total population

other factors that influence growth

Government policy, institutions, political and economic stability, geography, natural resource endowment, health and education services quality

Favorable Environment for Private Enterprise

Growth depends on millions of private citizens making decision to save, invest, work, educate, etc. Agricultural policies are central in Africa since 70-80% of the population lives from agriculture Hernando de Soto: regulation and weak property rights under mine or kill businesses

Value Added

Incremental gain to the price of a product at a particular stage of production

The Basic Growth Model: Aggregate Production function

Is based on five equations: 1. Aggregate production function Y=F (K,L) 2. Saving(S)= sY 3. S= I (Saving=Investment) 4. ΔK=(I- dK) where d=rate of depreciation and K= capital 5. Δ L= nxL n=population growth and L=Labor force Combining 2,3,4, leads to: ΔK =sY-dK 5 equations and 5 variables can be solved ΔK can be substituted into Production function Y=f(K,L)

Limitations of GDP/GNP Per capita

It does not include subsistence production in Developing Countries & Africa. Does not account for "public bads" such as Pollution, crime, congestion, etc. To capture this we need to calculate Net Economic Welfare (NEW) Exchange Rate problem-does not account for non-traded services such as haircut, maid services, shoe shine services that are very cheap in places like Africa.

Solow Model: Strengths and Weaknesses

It is an improvement over H-D Fixed coefficient model With neoclassical production function it allows for substitution between inputs Provides good insights about the relationship between role of technology and innovation on growth Limitations: One sector approach, factors that drive steady state, and assumes saving rate, population growth , and technical change as given. It does not explain how these parameters change over time

What Explains Differences in Growth Rates among countries( see Box 4.3)

Key factors from a recent study: initial level of income, openness to trade, healthy population, effective governance, high saving rate and geography The above policy variables explain the differences between 3 groups of countries from 1965-90

Different views on inequality and growth

Kuznets → Inequality may increase in transition from mostly agricultural society to an industrial one. Lewis's Surplus Labor model → inequality is not just a necessary effect of growth; it is a cause of growth. Better data and econometric techniques → lack of one general pattern → complexity of the process.

Distribution matters

Major explanation of the degree of absolute poverty = low level of total production per capita, but distribution of income (inequality) also plays a vital role. Both growth and inequality affect poverty If both matter, what is the policy implication? Pro-poor development strategy → - Encouraging rapid growth - Improving opportunities for the poor - Designing social safety nets

remittances

Money migrants send back to family and friends in their home countries, often in cash, forming an important part of the economy in many poorer countries

Favorable Geography or location

Most economically developed states are in Temperate climate Zone. Most developing countries are in the tropics. "The effect of climate": Andrew Kamrackargument. Does being land locked matter? (no coast line). Yes and no Botswana is land locked but it is most successful African Economy Switzerland and Austria are land locked yet they are wealthy countries.

All nations don't follow similar distributional path

Scope for government policy History and politics (e.g., South Africa, East Europe) Resource endowment and persistence of the past. Policy choices: -affect diffusion of technology and access to markets -taxes, social safety nets

Sen's Capability Approach

Sources of "capability deprivation" that prevent people the lives they desire. State of Health wellbeing Environmental Diversities Social climate: crime, violence, security Relative Deprivation & inequality

Strengths and Weaknesses of the HD Model

Strengths: - Simplicity - Small data requirement - In the absence of severe economic shocks, gives reasonable estimates of growth rates over a few years. Weaknesses - Strong focus on saving - Assumes one sector - Rigid assumption (fixed proportion, fixed K/L, K/Q, L/Q ) - Knife-edge problem ►g=n → econ in equilibrium. otherwise, econ falls off the edge with continuously growing unemployment of lab or cap. - Absence of the role of productivity growth.

Different methods of calculating international prices

The PPP method eliminates the effects of differences and changes in relative price levels (Non- tradables). The Atlas method dampens variability caused by fluctuations in exchange rates, Nominal GDP, perhaps the most familiar measure of aggregate economic activity, is most subject to price and exchange rate effects

New Approaches to Growth

The Solow model assumes fixed or exogenous saving rate, growth rate of savings and labor force. Recent works provide models where these variables are determined within or endogenously in the model. These new models allow for increasing returns to scale and positive and negative externalities They are called endogenous models but their estimation suffers from lack of good data.

Technological Change in the Solow Model

The basic Solow model (no technological progress): Once the economy reaches its LR potential level of income, economic growth simply matches population , growth (i.e., n) with no chance for sustained increase in average income. What explains historically observed increase in average income: Technological Progress •PF: Y = F(K, T*L) -Tech. directly enhances labor -Labor augmenting T*L = Effective units of labor •T*L measures the amount of labor and its efficiency. •Technological change and productivity growth more broadly allow output /income per worker to increase. •Assume technology improves at a constant rate (ѳ) (i.e., ΔT/T = ѳ) •If the work force is growing at n, growth in the effective labor supply = n + ѳ •Define ye = Y/(T*L) (output per effective worker) and ke = K/T*L •Then, can have output per effective worker ye =f (ke ) and saving per effective worker = s ye •With effective labor now growing at n + ѳ, the capital accumulation eqn. becomes Δke=sye-(n + d+ ѳ)ke

Capital deepening

The process through which the economy increases the amount of capital per worker (k).

Harrod-Domar Prod. function

The production function Y= (1/v).K or Y=K/v, where v= constant or v=K/Y v= capital output ratio or measure of the productivity of capital or investment. (indication of K intensity) For example if v=5, and a firm has $40m in capital, then its annual output will be 40/5 = $8m. The capital-output ratio is an important parameter of the model. A large v implies more capital is needed to produce the same output(e.g. if v = 6, need $48) The capital-output ratio provides an indication of capital intensity in production.

Trade Openness

Trade affects PCI by encouraging countries to accumulate both physical and human capital and by increasing productivity). But, does not say directly about the relationship between trade policy and growth

Measuring Inequality

Using frequency distribution & quintiles or shares of income or consumption (micro-level) We can get a measure of relative inequality in general by looking at table on comparative share of income or consumption of the three countries. Size distributions tell us the share of total consumption or income received by different groups of households, ranked according to their consumption or income level Simple calculation of Inequality using Range: Top 20%/bottom 20% - Range in Bangladesh = 41/9= 4.5 (4.5:1)(top 20% receive ab

2 problems with "a"

What are the factors causing a to improve? may be measured with error

"Point A" in the Solow Growth Model

__ is where new savings Sy = amount of new capital needed for growth in the labor force and depreciation (n+d). __ is steady state level of capital per worker where stable equilibrium occurs At steady state total output continues to grow at the rate of population (n) or labor force, but GDP per capital (y) is constant.

The Harrod-Domar Growth Model

a particular model with basic feature of fixed coefficient production function. It assumes no substitution between labor and capital Q= min F(L,K): the production Isoquant is L shaped It also shows constant returns to scale (CRS) i.e.doubling inputs will double output Constant capital-output ratio and labor-output ratio

Countries with the greatest potential for modern economic growth share the following common features:

an emphasis on education, highly developed institutions, common culture, self-government, and favorable geography

The Solow Model

an improvement over Harrod-DomarModel It drops fixed coefficient or no substitution and allows for substitution between factors Y= f(K,L) Labor and capital are substitutable The production function or Isoquantis u-shaped showing substitution Assumes diminishing returns to capital

Economic Development:

broader and implies improvements in health, education and other aspects of welfare (income distribution) Development = Economic Growth + structural change involving participation of people in the economy The process of improving the quality of all human lives and capabilities by raising people's levels of living, self-esteem, and freedom expanding capabilities of people's lives. Income is one determinant of that capability. Measurement: Income per capita is a key indicator but, one limitation is the international comparison requires converting country currency into a common currency A more accurate method is Purchasing Power Parity compared to using simple exchange rates conversion. This method shows that income differences between rich and poor countries are less acute than one finds in statistics based on exchange rates. Other methods include using physical measures of wellbeing such as Energy Use, life Expectancy, Adult Literacy, Proportion of rural population, etc.

Market stabilizing institutions

control inflation & minimize macro volatility

Conditional Convergence

controls for differences in factors like population growth.

Market regulating institutions

deal with market failure

Distribution of income

depends on ownership of factors and the role of each factor in the production process.

Political institutions

determine how a country is governed and the extent of political participation: level of democracy, transparency, free press, participatory politics, and competitive parties

Sustained development and poverty reduction cannot occur in the absence of

economic growth

Growth Accounting

gY= (Wk x gK) + (WL x gL)+ a For degree to which each attribute to growth rate: gk*wk/gy or gL*wL/gy gY= growth of income gK, gL= growth of capital and labor WL, WK= share in total income of wages and returns on capital. a= rate of change in TFP, rate of productivity of inputs= residual; measures the contribution to production of efficiency, technology, and other influences on productivity.

Productivity Growth.

greater efficiency-specialization, and technological change

Macroeconomic stability

implies: - Relatively low budget deficit - Prudent monetary policy (keeps inflation in check) - Appropriate exchange rate - Suitable financial markets

Modern economic growth

involves the application of Science and Technology for human progress

at the intersection (point A):

k=k0 and y=f(k)=y0 at A: sy=(n+d)k if k=k1 and y=y1: sy>(n+d)k, so k grows if k=k2 and y=y2: sy<(n+d)k, so k falls all move towards A!

The Hausmann-Rodrik-Velasco Growth Diagnostics (GD) Framework

once efficient investment & entrepreneurship are accepted for economic growth & development, there is need for country-specific binding constraints. GD is a decision tree for identifying the most binding constraints for each country currently and in future. 1. Focus on a country's most binding constraints on economic growth & alleviating pressing constraints 2. Suppose a country is constrained by low level of private investment & entrepreneurship. The decision tree identifies the-how-to-solve the problem. The initial causes could be (a) low return to economic activity and (b) high cost of finance 3. Not that the solution to these binding constraints are so many and multi-dimensional. This shows that No "one size fits all" in development policy, i.e. GD is a much more broader approach to development policy that complements econometric modelling. •Not simple to find the binding constraint. Uncertainty leads to probabilistic assessments

Globalization

one of the most important forces behind the following changes: •Political changes especially after the end of the cold war •Relationship between political change /democracy and economic development •Significant demographic changes (# of children, aging and implications on savings, tax revenue, pensions and other social programs) •Spread of endemic diseases •Increase in global trade •Faster movement of capital •Information and ideas spread much faster

market creating institutions

protect property rights, minimize corruption (rule of law)

Market legitimizing institutions

provide social protection and insurance

Gini Coefficient

relates cumulative % of income recipients (persons) to cumulative % of consumption or income received GCR= (A) /(A+B) where A= area of inequality GCR is between 0 & 1 If GCR=0 (Perfect equality) If GCR = 1 ( Perfect inequality)

Notice that ___ differences in growth rates can a make huge difference, especially over time.

small

Institutions (Douglass North)

the humanly devised constraints that structure human interaction. They are made up of formal constraints (rules, laws, constitutions), informal constraints (norms of behavior, conventions, and self imposed codes of conduct), and their enforcement characteristics. "the rules of the game."

Non-economic aspects of globalization

the integration of cultures, communications, and politics

economic globalization

the integration of the national economies into the international economy through trade in goods and services, FDI, short term capital flows, Investments in equipment, factories, stocks, bonds, international movement of people, and the flow of technology

GNP

the sum of all goods and services produced annually by a country's nationals, regardless of where they are located similar to GDP but includes the value of goods and services produced by citizens including those who live overseas.

GDP

the total market value of all final goods and services produced annually by companies within a given territory (country) measure of economic growth excludes intermediate goods such as wheat in the production of wheat bread. A measure of both total income and total output

Investment in Health and Education

this is key as it translates to longer life, healthier and productive population. are both input or means and outcome (goal) of development. Increase in the level and quality of both is crucial

HD Model: growth in output

ΔY=ΔK/v and g= ΔY/Y=ΔK/Yv ... growth rate of output since ΔK =sY-dK: g= (s/v)-d ... thus: 1.K created by I is the main determinant of growth in output 2.S makes I possible The Basic HD Model Point: S more and make productive I and the economy will grow. Example: if s=.24, v=3, and d=.05, then the economy will grow at 3% (why? s/v-d = 0.24/3 - 0.05 = 0.03=3%)

Why Inequality Matters

•Degree of inequality + level of income determine the extent of poverty. •If an economy grows and inequality remains unchanged → income of the poor grows along with others → poorest quintile have more income •If PCI unchanged and inequality goes up, poorest quintiles have less income. Inequality & growth are not determined independently. Their relationship is ambiguous/ complex Early theories: inequality might raise growth rate by improving saving But, when inequality is high, worthwhile investments may not be undertaken The political process is another channel that link inequality and growth. When inequality is high, the rich use their wealth to secure outcomes in line with their interest (e.g. , influence public spending or trade policy) Others argue that high inequality may lead to populist movements → higher taxes → less investment

Dimensions of Inequality

•Distribution of income •Distribution of consumption •Distribution of wealth

convergence

•Do economies that start off poor subsequently grow faster? •Diminishing MPK → Catching up •Whether 2 economies converge depends on why they're different in the first place.

Areas for accelerated progress and bolder action

•Environmental sustainability is under severe threat, demanding a new level of global cooperation •Big gains have been made in child survival, but more must be done to meet our obligations to the youngest generation •Most maternal deaths are preventable, but progress in this area is falling short. •Access to antiretroviral therapy and knowledge about HIV prevention must expand •Too many children are still denied their right to primary education •Gains in sanitation are impressive—but not good enough •There is less aid money overall, with the poorest countries most adversely affected

Three categories of inequality

•Low: GCR<0.4 •Medium: GCR (0.4-0.5) •High (GCR> 0.5)

•Rural-urban gaps persist

•Rural-urban gaps persist—access to reproductive health services and to clean drinking water are only two examples •The poorest children are most likely to be out of school •Gender-based inequalities in decision-making power persist

Easterlin Paradox

•There is no correlation between growth and happiness or growth does not increase happiness, but, there is some evidence of a positive relationship.