Global Economic Development Class

1
Global Economic DevelopmentClass 15

• Questions
• What is the relationship between financial
  development and growth? Mainly we will see after
  Spring Break.
• Is financial globalization any good? That is, is
  people better off? Today
• What are the determinants of financial
  development?

2

• Lucas Why does not capital flow from rich to
  poor countries?
• y Axa
• yincome per worker
• xcapital per worker
• r A a x a -1
• r a A1/a y(a -1)/ a
• a0.4, yUS15yI
• Then rI58 rUS
• Assumptions
• Same good
• Same constant returns to scale production
  function
• Homogenous capital and labor inputs
• Trade in capital is free and competitive
• Question which assumption we have to change to
  reconcile theory and facts?

3

• Relaxation of Assumption 3 Non-homogenous labor
  or differences in human capital
• Human capital per worker is higher in the US than
  in India. This alone explains that the average US
  worker should be 5 times more productive than the
  Indian (but not 15!).
• So using, yUS15/53yI (here y is income per
  effective worker),
• rI5rUS, much smaller than 58, but still big
  (think of an interest rate of 10 versus one of
  50!).
• 2. Relaxation of production function (external
  effect of human capital)
• New production function
• y Axah?
• hhuman capital per worker
• ?external effect parameter
• r a A1/a y(a -1)/ ah?/ a
• a0.25, then ?0.36

4
An increase of 10 in the average quality of
workforce, increases the productivity of any
individual in 3.6! Then rI almost equivalent to
rUS! Human capital plus external effects of human
capital solves the situation. (Observe that also
explains why people wants so much to migrate to
advanced countries their productivity is much
higher there!). But the spillover is just inside
the country? 3. Relaxation of Assumption 4
Imperfect capital markets Political risk? But
there was not so much political risk before 1945,
during colonial periods. For example, UK could
lend and enforce any contract as well in India as
in UK. Then, before 1945, any other reason for
different rates? Imperial power as a monopolist
generates differential rates.