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.
Download ReportTranscript 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.
Slide 1
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 2
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 3
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 4
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 5
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 6
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 7
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 8
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 9
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 10
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 11
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 12
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 13
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 14
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 15
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 16
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 17
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 18
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 19
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 20
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 21
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 22
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 23
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 24
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 25
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 26
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 27
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 28
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 29
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 30
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 31
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 32
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 33
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 34
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 35
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 36
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 2
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 3
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 4
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 5
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 6
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 7
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 8
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 9
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 10
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 11
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 12
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 13
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 14
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 15
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 16
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 17
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 18
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 19
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 20
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 21
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 22
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 23
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 24
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 25
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 26
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 27
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 28
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 29
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 30
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 31
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 32
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 33
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 34
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 35
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41
Slide 36
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
CONT..
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
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 knowledgebased 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.
13
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.
14
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 Sshaped curve intersecting a 45 degree line
When there is multiple equilibria, we usually
have a
lower stable equilibrium
higher stable equilibrium
Examples:
Coordinating investment decisions15
in a economy and Malthus population trap
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
18
sufficient condition for development
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 economic growth under way in the first
place and much easier to maintain it once a track
record has been established.
19
QUESTION RELATED TO BIG BUSH
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.
20
THE BIG PUSH MODEL
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
21
value in explaining the success of the East Asian
miracle economies, notably that of South Korea
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
22
THE BIG PUSH MODEL OF DEVELOPMENT
23
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
24
COORDINATION PROBLEM CANNOT BE
SOLVED BY A SUPER-ENTREPRENEUR
Why the problem cannot be solved by a superentrepreneur?
Capital market failures; bankers are unwilling to
provide loans to a single firm
Agency costs; expensive agency costs to ensure
compliance of employees (monitoring cost)
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 25
information about the importance of industrialization
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 lowincome 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 highskill 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
30
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 objectivesequity vs growth
Role of economics and economic principles
Policy alternatives and consequences- open for
discussion
32
ECONOMIC DEVELOPMENT AS SELFDISCOVERY
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
33
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
34
THE GROWTH DIAGNOSTICS FRAMEWORK
4-35
35
36
© 2011 South-Western, a part of Cengage Learning
36
Political Viewpoint Approaches
Neo-liberal /
Capitalist
Marxist/ Socialist
Populist
Grassroots
China, Asian
Tigers
Cuba, Kerala
(India)
Venezuela / Latin
America
Community
based
•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 37
other support.
•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.
37
Strategies
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
38
38
Global Players
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
39
common; developed world consumers may support fair trade.
39
40
Thanks
41