Why is Economic Development so Difficult 2 June 12 2003

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Why is Economic Development so Difficult?2
June 12 2003
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Review

• Many conceptions of human development
• Roosevelt four freedoms
• Sen sustenance, self-esteem, freedom
• Stiglitz transformation of society
• HDI life expectancy, literacy, enrollment, GDP
  per capita (PPP)
• Economic Growth correlates with human
  development, and in particular
• Growth helps the poor
• 1 in overall GDP per capita
  1 in GDP per capita for poorest 20

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Great Structural Diversity among Developing
Economies

• Size and income level
• Historical background
• Physical and human resources
• Ethnic and religious composition

• Relative importance of public and private sectors
• Industrial structure
• External dependence
• Political structure, power, and interest groups

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But, they face Common Challenges

• Extremely Low per capita GDP
• Low or negative GDP growth over time
• Growing disparity between richest and poorest
  countries

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Sructural Challenges

• High dependence on agriculture and primary
  product exports
• Rapid rural-urban migration
• Low levels of productivity
• High rates of population growth and dependency
  burdens

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Basic Structure of Economies Africa vs. Asia vs.
U.S.
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Deeper Economic Challenges

• Macroeconomic
• High inflation
• Black markets for foreign exchange
• Trade barriers imposed by rich countries
• External debt (?)

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Deeper Economic Challenges

• Microeconomic imperfect or missing markets
• Markets for borrowing, saving, and investing
  (credit and financial markets)
• Markets for spreading risk (insurance markets)

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Deeper Economic Challenges Imperfect Information

• Markets work well when buyers and sellers have
  good information
• Markets fail or dont exist when buyers or
  sellers (or both) have poor information
• Poor information is not the same as little
  information (recall our auction)
• Markets can work poorly when buyers have
  information but sellers do not, or vice versa
  asymmetric information

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Imperfect Information Example

• Lenders do not know if farmer is good credit
  risk
• Farmers have no collateral (the developed
  countries solution to this problem)
• Hence, farmer cannot get loan to buy land,
• Hence, farmer must somehow rent the land.perhaps
  by sharecropping
• Which does not give farmer full marginal benefit
  of his labor inefficient

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Without Credit and Insurance

• People live on the economic edge
• A small shock can mean ruin
• Illness ? cant work, no income
• no unemployment, no insurance
• Sell assets for medicine, food
• What assets???
• Future productivity drops

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Social Challenges Missing Institutions

• A market economy needs
• Security, peace
• Justice system to enforce contracts
• Financial system
• To collect funds from savers
• Allocate credit to borrowers
• Stable currency
• Transaction information (what am I buying?)
• Effective, fair, government

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What about Science and Technology?

• We will see that technological progress is the
  only real source of long-run growth
• Technology is already here..
• Why cant LDCs take advantage of past (and
  current) discoveries?

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Sachs Quadruple Bind

• 1) Innovation responds to demand. Demand comes
  from rich countries
• 2) Innovation requires critical mass of science.
  Poor countries have no critical mass
• 3) Existing knowledge applies to temperate zones
• 4) climate change limits world growth (shakier
  argument)

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Looking Ahead The Quest for Growth(in per
capita GDP)

• Does Aid for Investment for Machines cause
  growth?
• Does Education for Skills cause growth?
• (Does controlling population cause growth?)
• Does reducing debt cause growth?
• What is a poverty trap?
• How can people escape from poverty traps?
• How can policy and institutions be improved to
  help people escape from poverty traps?