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CONTEMPORARY MODELS OF DEVELOPMENT
Is Development possible?
Development is possible but extremely difficult!
It has been impossible for some countries (e.g.,
Nigeria, Sudan, or even Pakistan), but
accomplished by others (e.g., S. Korea, Singapore).
Thus an improved understanding of barrier and
catalysts of development is the utmost important.
Does it happen automatically?
It happens systematically!2
CONTEMPORARY MODELS OF DEVELOPMENT AND UNDERDEVELOPMENT
New theories that help us understand the barriers to development include
Endogenous growth
Coordination failures
Multiple equilibria
The Big Push
O-Ring theory
3
The new models of economic development have
broadened the scope for modeling a market in a
developing country.
Neoclassical assumption of diminishing marginal
return to capital investments, permitting increasing
return to scale in aggregate production.
Departs from neoclassical economics in its
assumptions of perfect information, the relative
insignificance of externalities, and the uniqueness
and optimality of equilibrium.
4
CONT..
THE NEW GROWTH THEORY: ENDOGENOUS GROWTH
The new growth provides a theoretical framework for analyzing endogenous growth, persistent GNP growth that is determined by the system governing the production process rather than by the forces outside the system.
Endogenous growth theory explains TFP “endogenously”
Advances in explaining growth rate differentials across countries.
New growth theories assume increasing returns to capital, permit increasing returns to scale and focus on the role of externalities in determining rate of return on capital investments.
Suggest an active role for public policy in increasing complementary investments
5
ENDOGENOUS GROWTH MODELS
Structural resemblance, however, differ considerably in their assumption and conclusions drawn.
The models imply that a country’s LR growth rate depends on its rate of savings and investment, not only on exogenous productivity growth
The models use the aggregate production Y=AK
Assume that marginal productivity of capital is constant as a result of concurrent investment in human capital and R & D
6
CONT..
Complementary investment produced social and private benefits.
Govt. should improve the efficiency of resource allocation by providing public good and or encouraging private investment.
Human capital accumulation subsequently can generate increasing return to scale.
So such growth theory models explain technological change as endogenous outcome of public and private investment in human capital and knowledge-intensive industries.
7
CONT..
Endogenous growth theory holds that economic growth is primarily the result of endogenous and not external forces.
Endogenous growth theory holds that investment in human capital, innovation, and knowledge are significant contributors to economic growth.
The theory also focuses on positive externalities and spillover effects of a knowledge-based economy which will lead to economic development.
8
NEW APPROACHES TO GROWTH
New research reveals that GDP growth in many of
the technologically advanced countries has had to
do largely, even principally, with TFP growth (i.e.,
increases in productivity).
Furthermore, research has been conducted on why
productivity growth has such a major impact? And
one explanation is that there are increasing
returns to investment in knowledge. This may
be a result of positive externalities (spillovers).9
THE ROMER ENDOGENOUS GROWTH MODEL
To demonstrate the endogenous growth models: let us examine the simplified form of Romer endogenous growth models.
The model addresses technological spillovers that may be present in the process of industrialization
The aggregate production function is similar to that of Harrod-Domar model and endogenises why growth might depend on investment
As a result of saving, investment (knowledge/ know-how) spillovers occur leading to higher rates of growth
Drawbacks of the theory/model 10
UNDERDEVELOPMENT AS A COORDINATION FAILURE
Influential during 1990- early 2000 Emphasizes that complementarities between
several conditions is necessary for economic development.(skill or demand for skill)
Coordination failures results in (bad) equilibrium in which agents are worse-off than in alternative (situation of) equilibrium
Deep interventions by the government can move an economy to a preferred equilibrium. Then govt. has no need to continue the intervention because the better equilibrium will be maintained automatically.
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CONT..
Complementarities versus congestions In the absence of complementarities, such as in
competitive markets; when there is excess demand there is counter-pressure for the prices to rise, restoring the equilibrium.
Whenever, congestions may be present, these counter-pressures are very strong.
Furthermore, in the process of economic development, joint externalities are common: underdevelopment begets underdevelopment, while the process of sustainable development, once underway, tend to stimulate further development.
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ILLUSTRATION OF COORDINATION FAILURE : MULTIPLE EQUILIBRIA
Equilibrium occurs when agents do what is best for them and when agents observe what they expected to observe
Multiple equilibria is illustrated using a S-shaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually have alower stable equilibrium higher stable equilibrium
Examples: Coordinating investment decisions in a economy and Malthus population trap
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ILLUSTRATION OF COORDINATION FAILURE : MULTIPLE EQUILIBRIA
Lower stable equilibrium occurs when only a few agents take a complementary action and spillovers are minimal
Higher stable equilibrium occurs at a stage when many agents have taken the complementary action that they all enjoy the positive benefits of the spillovers
Government intervention can change expectations of individuals and thus move the economy from low to high stable equilibrium
Technological availability is a necessary but not a sufficient condition for development 18
THE BIG PUSH MODEL OF DEVELOPMENT
The big push model shows how market failures can be mitigated by serious public policy –led efforts to get the long process of economic development underway or to accelerate it.
It is the most famous model of coordination failures and it emphasizes the existence of increasing returns in the modern, industrialized sector
A look at the record, however, allows us to agree with Rostow at least in that it is very difficult to get modern eco nomic growth under way in the first place and much easier to maintain it once a track record has been established. 19
CONT..
Why should it be so difficult to start modern growth?
Under perfect competition, it is not clear why starting development would be so difficult, provided at least that the needed human capital is developed, the technology transfer problem is adequately addressed, and government provides other essential services.
But development seems hard to initiate even when better technologies are available—they often go unused.
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CONT.. Rosenstein-Rodan's arguments became a major
part of the way development economists thought about development problems in the 1950s and 1960s, and they have continued to be taught in development courses.
But while some of the basic insight has thus been around for decades, the approach received a huge boost following the 1989 publication of a technical paper by Kevin Murphy, Andrei Shleifer, and Robert Vishny, which for the first time demonstrated the formal logic of this approach more clearly.
Its recent appeal is also due in part to its perceived value in explaining the success of the East Asian miracle economies, notably that of South Korea
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THE BIG PUSH MODEL OF DEVELOPMENT
Assumptions:
1. Factors
2. Factor payments
3. Technology
4. Domestic demand
5. International supply and demand
6. Market structure
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THE BIG PUSH MODEL OF DEVELOPMENT Other cases in which a big push may
be necessary: Intertemporal effects; investment in the
modern sector becomes profitable over-time as the market size increases
Urbanization effects; demand for manufactured goods increases with urban population growth
Infrastructure effects; improvement in transportation, communication, and distribution systems reduces the cost of investment
Training effects; the labor force becomes more productive and skilled with education
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COORDINATION PROBLEM CANNOT BE SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a super-entrepreneur?
Capital market failures; bankers are unwilling to provide loans to a single firm
Agency costs; expensive agency costs to ensure compliance of employees
Asymmetric information; agents do not know that other firms are investing in modern technology
Communication failures; agents wanting to share profit cannot convince the super-entrepreneur to do so
Limits to knowledge; agents do not have sufficient information about the importance of industrialization
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FURTHER PROBLEMS OF MULTIPLE EQUILIBRIA
The presence of increasing returns in modern industries can create bad equilibrium
Inefficient advantages of incumbency Behavior and norms of individuals in an
economy Public policy identifying linkages (forward and
backward) and targeting investment in these industries could be a solution.
26
KREMER’S O-RING THEORY OF ECONOMIC DEVELOPMENT
Provides insights into low-level equilibrium traps and explains the reasons for the existence of poverty traps and why countries with low-income are caught in these traps
The theory models production with strong complementarities among inputs
The production function assumes that output is derived by multiplying level of skill required for completing a task by the total number of tasks 27
KREMER’S O-RING THEORY OF ECONOMIC DEVELOPMENT
The production function is characterized by positive assortative matching and therefore total output will always be high under a matching scheme
Positive assortative matching relies on two strong assumptions
Workers are imperfect substitutes for one another
There is sufficient complementarity of tasks
28
IMPLICATIONS OF THE KREMER’S O-RING THEORY
Firms tend to employ workers with similar skills for their several tasks
Workers performing the same task at a high-skill firm earn higher wages
Wages are proportionally higher in developed countries because wages increase at an increasing rate
Levels of human capital investment made by other workers is an important determinant of worker’s decision to improve her skill level 29
IMPLICATIONS OF THE KREMER’S O-RING THEORY
Firms would worry about their productivity only if
other firms are trying to increase their quality
Due to O-ring effects across firms, economy
could be caught in low-production-quality traps
O-ring effects magnify the impact of production
bottlenecks
Bottlenecks reduce worker’s expected return to
investment in her skills
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IMPLICATIONS OF THE KREMER’S O-RING THEORY
Trade could mitigate bottlenecks and low levels of skills.
The choice of technology depends on skill level of workers.
Developed countries have high skilled workers and therefore large specialized production processes.
International brain drain occurs because a worker from a developing country receives a higher wage for the same skills.
31
DOMESTIC PROBLEMS AND POLICIES
Statement of the problem
Relative importance of the problem in
developing countries
Possible development goals and objectives-
equity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open
for discussion32
ECONOMIC DEVELOPMENT AS SELF-DISCOVERY
Hausmann and Rodrik: A Problem of Information Not enough to say developing countries should
produce “labor intensive products,” because there are thousands of them
Industrial policy may help to identify true direct and indirect domestic costs of potential products to specialize in, by:
Encouraging exploration in first stage Encouraging movement out of inefficient sectors
and into more efficient sectors in the second stage
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THE GROWTH DIAGNOSTICS FRAMEWORK
• Focus on a country’s most binding constraints of economic development: low rate of return on investment and high cost of financing
• No “one size fits all” in development policy of market coordination
• Insufficient investment in physical, social, environmental, and human capital
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Neo-liberal / Capitalist
Marxist/ Socialist
Populist Grassroots
China, Asian Tigers
Cuba, Kerala (India)
Venezuela / Latin America
Community based
•Market led development, following the ‘Modernisation Theory’ of WW Rostow•Stressing industry and infrastructure, free trade and attracting foreign direct investment to create jobs and raise incomes.
•Breaking free of capitalism and profit.•State ownership and planning so that profits from industry and uses for health and education; usually involves wholesale land reform .•State control and limited involvement in world trade and TNCs
•Charismatic ‘man of the people’ leaders create a ‘them and us’ discourse promising social equality and using policies that appeal to the pockets of ordinary people•Critics state populism is directionless and leads to poor economic decision-making
•Small-scale, community focussed development often aiming to meet basic needs rather than hugely improve incomes•Often involves local or international NGOs who provide some funding and other support.
Political Viewpoint Approaches
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Bottom up Top Down
Scale Small; based on one community or area e.g. a valley
Large; often part of national planning aims
Leadership Community and NGOs; partnership arrangements
Government and government agencies; construction and engineering TNCs
Funding source
Local people and NGOs; donations or earned income recycled into the community
Government, via multilateral aid (WB / IMF) or bilateral aid; private investment
Aims Meeting basic needs of food, health, education and water; small improvements in income
Meeting national needs in terms of energy or water supply, or transport; profit
Technology
Intermediate / appropriate Hi-Tech
Types of project
Food production, water supply, small scale renewable energy
Electricity, transport, industry and infrastructure
Winners Local people; the environment Industry, urban dwellers, TNCs
Losers Usually are none Environment, rural people
Strategies
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Player Role
World Bank / IMF These two IGOs lend money to the developing world – essentially funding development, and as part of this process guide economic policy (the IMF). Much of the developing world’s debt is owed to the IMF and WB.
TNCs Invest in the developing world e.g. building factories; Foreign Direct Investment tends to flow to low cost locations, but where people are educated and skilled; Africa’s share of FDI is therefore small.
United Nations Monitors the MDG, but has many component organisation which focus on development (UNDP), health (WHO), food and farming (FAO) and environmental issues (UNEP); often involved in disaster relief as well as longer term aid.
Governments Developed world governments provide funding for the UN, IMF and WB. They also provide bi-lateral aid the developing world in the form of Official Development Assistance (ODA). Developing World governments manage their countries path to development.
NGOs Charities and not-for-profit organisations provide aid to the developing world, often in a smaller, more localised way compared to Governments and IGOs. Some NGOs receive government funding
Individuals As consumers and voters, individuals can alter government policy both in the developed and developing world; community led development in becoming more common; developed world consumers may support fair trade.
Global Players
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