Global Economic Development Last class

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Global Economic DevelopmentLast class
Putting everything together Questions Why count
ries differ in levels of output, in output growth
rates and, more generally, economic development?
More general question, how to increase happiness
in the world?
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• Final objective of research on economic and
  social development
  
• Happiness of members of society they should
  feel satisfied and full-filled in their lives
  
• It includes
• Freedom choose way of living, choose type of
  work, choose partners, friends
  
• (Amartya Sen Development as freedom)
• Good health
• Self-respect
• Good education
• Leisure time
• Joy
• Hope of improvement
• Determinants of happiness
• economic (in these the economist focus mostly)
• power relations not directly related to
  economics (racial power, gender power)

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• Three determinants of happiness in which
  economists focus (and it is reasonable that they
  focus in these determinants)
  
• Average income per capita in society (in other
  words, is the society rich or poor?)
  
• Inequality in income per capita (in other words,
  is society fair or unfair at one point in time?)
  (Of course there is decreasing marginal value of
  increased equality)
• Upward mobility (in other words, is society fair
  or unfair intertemporally?)
  
• Why these determine (in part) happiness?
• Freedom is scarce if you can not choose (say,
  between owning a home and improve it or renting
  or between having a car or biking). Without
  income most people can not develop a free life.
• Without some basic income, people can not get
  education, health care, leisure.
  
• With too much economic inequality, power
  relations determine choice and again there is no
  freedom.
  
• With no upward mobility there is no hope of
  improvement.

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• So, what determines the economic determinants of
  happiness.
  
• First, what determines average income per capita
  in society?
  
• Proximate causes
• Physical capital e.g. a machine, a road, rival
  goods (embodied technology)
  
• Technology (or knowledge) e.g. the contents of
  an engineering book, non-rival good
  
• Human capital e.g. skills of a person, rival
  good (embodied knowledge)
  
• Social capital e.g. trust, non-rival good
• Organizational capital e.g. knowledge of an
  optimal process by a firm, rival good (it is
  similar to human capital, but the knowledge is
  embodied in a group of persons, a firm, instead
  of an individual)
• Natural resources (geography) e.g. land,
  minerals, rival goods
  

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• What is important in this classification?
• Which resources are subject to decreasing
  returns and which to constant or increasing
  returns? Technology improvement (knowledge) seems
  at the core of the possibility of permanent
  growth in income per capita
• Observe the complementarities
• i) sophisticated physical capital must be used
  with high human capital
  
• ii) technology improvements are caused by
  increased human capital, but also led to increase
  in human capital (though not always) (for
  example information technology creates a demand
  for computer engineers, but computer engineers
  create new IT technologies)
• Next step
• What determines the growth and levels of the
  resources?
  

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• At the center of the process of growth of income
  per capita, I would put the division of labor and
  production specialization.
  
• This, as emphasized by Adam Smith, causes three
  effects
  
• Increase dexterity of workmen (increase human
  capital)
  
• Savings in time in changing activities (increase
  in organizational capital)
  
• Promotes invention of machines (increase in
  technology and physical capital)
  
• The division of labor is accompanied by emergence
  of local trade (trade between people in different
  occupations) and international trade (trade
  between countries that specialize in different
  goods)
• Trade makes the diffusion of disembodied
  technology (knowledge) across people and
  countries much easier (there is contact and
  communication).

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• But what are the determinants of the division of
  labor, which determine the accumulation of
  resources as well as the creation of new
  technologies, which determine growth rates of
  income per capita, which determine levels of
  income per capita, which determine (partly)
  happiness?
• Extent of the market (including population size
  and income of those people)
  
• Coordination costs
• Knowledge
• Observe that there at least to circular flows
  here
  
• extent of the market causes division of labor
  causes increase in resources per capita causes
  increase in income per capita which increase the
  extent of the market
• general knowledge increases the division of labor
  which increases general knowledge)

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What determines the extent of the market and the
coordination costs? Answer Institutions. These a
re the rules of the game, or the constraints of
it. And here is where the government is
fundamental. These can be formal (e.g. protecti
on of property rights by law) or informal (e.g.
protection of property rights by ethic behaviour
or by watch of neighbours), political
institutions (e.g. constitution) or economic
institutions (e.g. regulation)
Institutions can be good or bad in the first
case they increase the coordination costs and
reduce the extent of the market, in the second
they do the opposite. So institutions determine t
he division of labor which determine in turn
productivity. Also, institutions determine that t
he resources are used in productive activities
and not destructive. In other words they diminish
as much as possible disorder (market failures)
and dictatorship (government failures or grabbing
hand). Institutions should be constructed to
reduce conflicts wars, strikes, lawsuits, crime.
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• A few more points
• Social capital increases financial development
  that makes accumulation of capital easier
  
• Human capital accumulation is accompanied by
  reduction in fertility which makes most of the
  production growth to be translated into income
  per capita growth
• Population growth extends the market as well as
  extend the pool for ideas and technology
  innovations.
  
• Medical knowledge diminishes mortality and
  increases longevity which increases the return to
  human capital.
  
• Observe that the conditions of Rodrik appear
  repeatedly
  
• protection of property rights and enforcement of
  contracts reduces coordination costs and
  increases the returns to accumulation of capital
  
• macroeconomic stability satisfies the same
  purpose
  
• integration into world markets increases the
  extent of the market and increases the diffusion
  of disembodied technology
  
• social cohesion and political stability reduce
  conflicts

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• But what about the other economic objectives
  reduction of inequality and increase in upward
  mobility.
  
• There may be some trade-offs.
• Protection of property rights can increase
  average income per capita but not decrease
  inequality. It seems that is what happened in
  Latin America for some periods of its history
  (for example, 1880-1930).
• The institution of inheritance can increase the
  incentive to accumulate capital by the parent but
  decrease the social mobility of the society.
  
• But, it seems to me, that generally there is no
  trade-off good institutions should increase
  average income per capita, decrease inequality
  and increase upward mobility. For example, as
  Schwartz mentions, focused increase in public
  schools funding would increase the skills of
  relatively bad students, increase their
  productivity and therefore increase the
  productivity of the whole society.
• A reduction in uncertainty would increase the
  savings of the population, increase the financial
  development and increase credit where the
  marginal product is higher, including poor but
  talented people and entrepreneurs. (One can see
  this in upward mobility of immigrants).

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Another caveat is that good institutions for
growth can be no so good for happiness. As
economic determinants of happiness are not the
only determinants, if institutions for growth
also affect the other determinants, it could be
affecting negatively happiness through this
other channel. As we have seen, power is another
determinant of freedom and happiness. Some
authors noticed that with the end of slavery
black population income per capita might have
diminished (Fogel). But most surely their
happiness increased. Freedom is determined not
only by income per capita but also by power
relations. Again, this caveat does not seem too i
mportant. Power and income are more and more
correlated. Today good institutions that promote
increase income per capita seem also to improve
other direct causes of happiness.
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• Recommendations
• So what are the recommendations, actions for the
  future?
  
• For governments
• i) Debate should not be about laissez-faire vs.
  interventionism it should be about wise (or
  common-sense or efficient) regulation vs. stupid
  (or inefficient) regulation. Or, in other words,
  institutions that balance efficiently
  (minimizing) disorder and dictatorship.
• ii) World is changing fast. Regulations should
  be flexible so that they can change with the
  world.
  
• iii) Institutions should try to diminish
  coordination costs (in particular, conflicts) and
  increase the extent of the market.
  
• iv) Main objectives (reduce uncertainty for
  majority of actors but not by reducing mobility
  or dynamism)
  
• social cohesion
• macro stability
• defense of property rights and contract
  enforcement
  
• integration to world economy

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• For firms
• Look for opportunities in services markets (or
  more sophisticated markets)
  
• Look for opportunities in emerging markets (as a
  higher and higher fraction of the world is
  developing)
  
• Look for opportunities in markets that focus in
  aging consumers (as the age structure of the
  population is changing).