Economic Development Textbook Notes Chapter 2
Economic Development Textbook Notes Chapter 2 ECN 201 10
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Date Created: 09/25/16
The Economics of Development Textbook Notes (Economic Development Todaro Smith) Chapter 2: Comparative Economic Development Introduction: - Inequality is one of the most defining characteristics of the world today - LDC’s share: o Lower living and productivity levels, lower industrialization, lower human capital o Higher inequality, higher absolute poverty, higher social fractionalization, larger rural population o Underdeveloped markets, adverse geography, lingering colonial impacts 2.1 Defining the Developing World - world generally defined by per capita income World Bank= an organization known as an international financial institution, provides development funds to developing countries - World Bank ranks countries by GDP per Capita and classifies them as LIC, LMC, UMC, and OECD Low Income Country(LIC)= GNI per capita less than $976 in 2008 Middle Income Countries (LMC and UMC) = (lower middle and upper middle) GDP between $976-$11,906 in 2008 - ‘developing’ generally means all but the OECDs, so anything below $11,906 Newly Industrializing Countries= distinction sometimes drawn between UMC’s and newly high income countries, developing dynamic industrial sector and building links to international trade, finance, and investment Least Developed Countries= (LDC) UN designation of countries with low income, low human capital, and high economic vulnerability - 49 countries are ranked LDC (mostly in Africa and Asia) - another term being used synonymously is ‘emerging markets’ to give a nod to progressing markets with investments and trade growth 2.2Basic Indicators of Human Development PPP: GNI= gross national income, total domestic and foreign output claimed by residents of a country (also GDP) - factor’s in incomes earned by foreign residents MINUS income earned in domestic economy by non-residents value added= portion of a product’s final value added at each stage of production depreciation= wearing out of equipment and infrastructure resulting in capital goods losing value over time capital stock= total amount of physical goods that have been produced for use in production of other goods and services (amount of equipment and machinery, steel) GDP= total final output of goods and services produced by a country’s economy WITHIN BORDERS by residents and non-residents, regardless of allocation between domestic and foreign claims PPP= purchasing power parity, a GNI calculation taking the cost of living into account for comparing living standards - otherwise income inequality is drastically exaggerated Indicators of Health and Education: - other measures besides income provide a more complete picture of the difference in wealth between countries o health, education, etc. are considered “basic indicators” 2.3Hollistic Measure of Living Levels and Capabilities - the UN Development Program’s Human Development Reports rank nations based on longevity, knowledge, and living standards to categorize countries into 4 levels for human development Human Development Index= index measuring national socioeconomic development based on combing measure of education, health, and adjusted real income per capita - index is always shown as a number between 0 and 1 or as a percentage Diminishing Marginal Utility= subjective value of additional consumption lessens as total consumption grows - like when you eat a brownie, the first bite is fantastic, second bite amazing, third bite great, till the last bite is not bad and now you hate yourself because you actually ate 5 brownies so that last one tastes more like guilt than anything - the human development index is measured by averaging three other indices: The Life Expectancy Index, Education Index (a combo of adult literacy and gross enrollment) and GNI per capita o Life expectancy is measured as (current expectancy – 25)/ (85- 25), with no DMU assumed o Education Index: 2/3(adult literacy% /100) + 1/3(% enrolled/100) - HDI= 1/3(GNI per Capita Index) + 1/3(Education Index) + 1/3(Life Expectancy) o This formula emphasizes that development is not just about income growth o Formula has been criticized for “enrollment index” because enrolled doesn’t mean someone actually finished schooling, and does not consider quality of education Human Capital= productive investments in people such as skills, values, and health resulting from expenditures on education, on-the-job training, and medical care - HDI rises with income, but there is still large variation between countries with similar income and HDI o Important to display inequality within countries: Brazil is wealthy but has vast amounts of poor…why? The New HDI: - changed in 2010 to address criticism 1. GNI replaced GDP because it incorporates what people do with income and how income is earned abroad 2. education index now includes average education attainment per years attended 3. expected education achievement index now included in UN measure 4. literacy and enrollment no longer included indices because they aren’t reliable to begin with 5. maximum values changes to show small gains for countries starting at very low levels 6. lower goal for income has been reduced for the same reason 7. use a natural log for equations rather than a common log 8. computed with a geometric mean now 2.4 Characteristics of the Developing World: Diversity within Commonality - different development problems call for different specific policies and strategies Lower Levels of Living Productivity: - Even with PP incorporated, the variation in GDP per capita is huge - At the lowest income levels, a vicious cycle develops where decreased spending on education and investment –due to lower income levels- results in lower per capita productivity and economic stagnation, which causes income to drop, and around it goes - Low income doesn’t mean being too small to generate enough product or too large a population to overcome economic inertia o There is no correlation to population size and economy size Lower Levels of Human Capital: - Health, education, and skills are essential for economic growth - health and education themselves are very strongly interrelated o For Example: child mortality rates improve as mother education increases Higher Levels of Inequality and Absolute Poverty - 1.4 billion people live in extreme poverty (less than $1.25 a day) - increased income is very unequal in countries in Latin America and Africa o these are generally very resource rich countries - extreme poverty from low human capital, sociopolitical exclusion, and other deprivations absolute poverty= situation of being unable/barely able to meet subsistence essentials (food, clothing, shelter, and basic healthcare) - subsistence levels vary between countries because they have difference socioeconomic requirements Higher Population Growth Rates: - more than 5/6 of the globe lives in developing countries - LMC’s and UMC’s have huge variation in birth rates Crude birth rate= the number of children born alive each year per 1000 of the population - High birthrate means the labor force has to support more people than in wealthy countries Dependency burden= proportion of population age 0-15 and 65+ (considered economically unproductive) not counted in the labor force - In rich countries the 65+ group is supported by pension which doesn’t exist in lower income countries o LDC labor force has to support double the population of OECDs, both 0-15 AND 65+ Greater Social Fractionalization Fractionalization= significant ethnic, linguistic, and other social divisions within a country - High in LDC’s, often results in violent conflict - Issues like low schooling, political instability, weak financial systems and infrastructure are explained by fractionalization o Inequalities in the population keep certain groups from ever gaining prosperity, and prevents cohesion in institutions - Greater fractionalization increases the likelihood of internal strife and political instability - Ethnic and religious diversity does not result in turmoil or instability; it hinges on the ability for groups to cooperate o If certain groups are in power and others are discriminated against it will result in decreased efficiency economically and politically Larger Rural Populations with Rapid Rural-to-Urban Migration: - Population shift from agriculture to manufacturing and service industry (combined with rural-to-city migration) is a huge indicator of development o Dark side is it can create tremendous infrastructural strain Lower Levels of Industrial and Manufacturing Exports: - Industry is always associated with greater development, and is usually prioritized by the government - Emerging countries are slowly moving away from agricultural and mineral-mining and more are classified as LMCs and UMCs, they are industrializing rapidly - LDC’s are still heavy on agriculture and resource mining, they have low product diversification which makes them very dependent on the market winds globally (not stable) Adverse Geography: - Most developing countries are sub-tropical, meaning they’ve had to deal with parasites and pests, extreme heat, and global warming is only exacerbating this Resource endowment= a nation’s supply of usable factors of production such as raw materials, minerals, labor - Some countries face the “curse of natural resources” o The DRC struggles with conflict over profits from raw materials, the result is a lot of fighting and the economic reliance on one industry (mining) Underdeveloped Markets: - Underdeveloped markets lack: 1. A legal system for property rights 2. A stable currency 3. Good infrastructure 4. Efficient insurance and banking systems 5. Available market information on the prices of goods 6. Conducive social norms for free trade (no bribery etc.) Imperfect market= the theoretical assumptions for perfect market competition are violated by things like low numbers of buyers or sellers, barriers to entry, and incomplete information for efficient decision making - The result is an underperforming market Lingering Colonial Impacts and Unequal International Relations: Colonial Legacy: o The effects of colonization’s leftovers o stunted government and institution growth o poorly formed markets lingering years after being officially ‘free’ o colonial governments also reinforced inequality and often incorporated/created ethnic divisions to maintain control (think Rwanda) result today is that inequality is incorporated in all aspects of these baby governments o “middle-income trap” where cultural barriers make it impossible for any but an elite group to make above the middle class income External Dependence o LDC’s are less organized and less influential globally, with less control over institutions that are supposed to help them (World Bank, WTO etc.) o They can’t protect themselves from unfair protectionist policies by developed countries and are dependent on political good will of the OECDs 2.5 How LIC’s Today Differ from OECD’s in Earlier Stages - 8 significant differences 1. physical and human resources 2. per capita income and GDP compared to the globe 3. climate 4. population size, growth, and distribution 5. historical role of internal migration 6. international trade barriers 7. basic science and technology R&D capabilities 8. domestic institution efficiency Physical and Human Resource Endowments: - LDC’s are now less endowed than OECD’s were when they were developing (generally) - LDC’s have much lower human resources, relatively less educated and skilled than OECD populations were - Unable to maintain long-term growth because they don’t have a base to build off of - There’s a huge idea gap (ability to solve technological and social problems) Relative Levels of Per Capita Income and GDP: - GDP etc. relatively lower in LCD’s than it was for OECD’s at the same stage - Today’s developed world was advanced even then for its time (relatively) so the gap widened Climatic Differences: - Colonists left less helpful institutions in climates they found uncomfortable - Hot areas with high humidity also experience rapid soil deterioration which is a struggle for agriculture Population Size, Distribution and Growth - OECD’s had slow population growth which gradually increased parallele to industrialization, then slowed down - LCD’s now are rapidly increasing population but not at an equal rate with industrialization, as a result the country can’t support the population Historical Role of International Migration - Before, excess population would migrate to find more jobs but now the places they need to go are too far away to relieve unemployment pressures o Some still have managed to move to low pressure areas in OECD’s, prompting rise of nationalist feelings and immigration restrictions brain drain= emigration of highly educated and skilled professionals and technicians from the developing countries into the developed worlds - Loss of intellectual resources hurts developing countries, only positive is that it encourages others to gain more education o Brain drain didn’t happen in OECD’s when they were developing, the intellectuals were forced to stay and build up their country because there weren’t better opportunities elsewhere The Growth Stimulus of International Trade: Free trade= trade in which goods can be imported and exported without any barriers in the form of tariffs, quotas, or other restrictions - Propelled development of today, allowed for product diversification - Non-oil-exporting countries struggled in the 19 century Terms of trade= ration of a country’s average export price to its average import price - Post WW1 developing nations received lower prices for some goods OECD’s sold pre WW1 - Developing countries usually used tariffs against cheap goods from OECDs but this prevented free trade and halted their growth in the end o example: China blossomed after abandoning protectionist policies Basic Scientific and Technological Research and Development Capabilities - OECDs stay on top by continuing to generate and apply technological innovations made possible by surplus wealth (allowing for specialization) Research and Development= (R&D) scientific investigation with a view toward improving the existing quality of human life, products, profits, factors of production, or knowledge - R&D goes towards solving the problems of OECD’s, and LCD’s don’t have enough money to facilitate the amount of R&D to fix their problems and work towards long-term interests - Must focus instead on simpler products and smaller markets - LDC’s are playing catch-up, OECD’s continue to move ahead Efficacy of Domestic Institutions: - at early stages most OECD’s had institutions, with economic rules providing access for driven people, but colonialism prevents this - institutions change very slowly, so it’s hard to get rid of poor ones - OECD’s had more flexible social and political flexibility and mobility for people o Ways to deal with social pressures and unrest other than descending into civil war 2.6 Are Living Standards of Developed and Developing Nations Converging? Divergence= tendency for per capita income to grow faster in higher-income countries than in lower income countries so the income gap widens across countries over time Convergence= tendency for per capita income to grow faster in LDC’s than OECDs so that the LDC’s are catching up and will achieve “conditional convergence” when (other things equal) income evens out - Technology transfer should help them catch up, “advantage of backwardness” is that they don’t have to ‘reinvent the wheel’ - LDC’s have high amounts of resources like people AS WELL AS high factor resources which OECD’s no longer have (they used them up during their own development) Relative Country Convergence: - Basic income is looking at LCD growth compared to OECD growth or the relative income gap - No apparent tendency demonstrated for convergence (49 at the bottom show no sign of catching up) - All OECD’s are converging with each other, but the LCD’s aren’t catching up with them Absolute Country Convergence - Even though countries like China have rapid growth they are still ‘losing’ based on absolute wealth. And this gap will continue to widen for a while before it starts to close Population-Weighted Relative Country Convergence: - Takes huge influence of population for India and china out of the picture when comparing; result is that there has been a convergence since 1989 World-As-1-Cpnvergence: - This calculation is very hard to do accurately and so isn't used 2.7Long-Run Causes and Comparative Development - In the long run geography doesn’t matter as demonstrated historically, but today it is less clear in its impact Economic institutions= “humanly devised” constraints that shape interactions in an economy, including formal rules embodied in constitutions, laws, contracts, and market regulations, plus informal rules reflected in norms of behavior, conduct, values, customs, and generally accepted ways - Property rights remove anti-competitive behaviors, social insurance encourages economic participation - Those established in colonies were often not conducive to long-term market growth o Did this frequently in harsh environments that colonial powers weren’t accustomed to Example; difference between institutions developed in north America compared to Africa - Most productive colonies in the past are now the least productive countries because they were domineered by their colonial powers - Varying degrees of enforced inequalities have long-term influence on post-colonial institutional inequalities - “never colonized” countries like Thailand and china show qualities of initial institutions matter and are not solely based on colonial presence - “once institutions are accounted for, trade itself explains very little” - forces protecting elites and keeping broader population out of the market hurts development; institutions resistant to reform also prevent development 2.8 Concluding Observations: - all historically founded problems have solutions - major structural and social changes must occur globally in LCD’s and OECD’s both - some “advantages of backwardness” can help countries skip development levels, but it’s mostly harmful
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