Introduction to Development Economics

1
Introduction to Development Economics

• Economics
• knowledge about the effective use of resources
  in producing the material basis of life.
• A social science.
• Development
• improving the conditions of life.
• all theories of development have significant
  economic dimensions.
• Growth vs. Development based theories
• Highly specialized, and arguably inconsistent,
  philosophical bases
• How useful are market based policies in
  development oriented policy?

2
Preclassical Beginnings

• Midieval theorists incorporated religious
  principals in economic theory.
• Assumed moral limitations on the economic actor.
• Every commodity had a just price, or absolute
  value.
• Estimated cost of production (typically labor
  input).
• Wage labor carried connotations of slavery or
  punishment

3
Emergence of the Work Ethic

• Labor emerged as a virtuous source of wealth.
• Acquisitiveness changed from sinful behavior to a
  community service.
• Classical economic theory was based on
• new attitudes toward labor, wealth, and
  productive life.
• Mercantilism a system of ideas, politics,
  institutions, and economic practices.

4
Mercantilism

• Shifted the focus of national power to economic
  means
• Production the application of labor to natural
  resources.
• Colonialism driven by quests for labor, raw
  materials, and markets.
• State policy focused on increasing the well being
  of the state
• increasing national control over productive
  resources (labor).
• positive balance of trade.
• Assumed that individuals acted in their own self
  interest.
• Trading monopolies and joint stock companies.

5
Emergence of Free Market Principles

• Efforts to harmonize individual self interest and
  the public interest, without state intervention.
• Equilibrium forces of supply and demand.
• just prices through market forces
• Increased productivity through specialization and
  division of labor.

6
Precursors to Capitalism

• Accumulation of land and currency in excess of
  immediate needs
• Application of wage labor to excess land
• increased production
• legitimized excess individual appropriation
• Shifted focus from the State to individual
  enterprise

7
Classical Economics

• Combined political economy with moral philosophy,
  focusing on
• causes of growth in wealth
• social results of development (on lowest orders
  of society)
• Theory of Moral Sentiments
• restraint of self interest within socially
  desirable limits (based on impartial observer)
• The Wealth of Nations (growth objective)
• trade driven by self interest (mitigated by
  virtue)
• capital accumulated through saving

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The Wealth of Nations

• No artificial impediments to trade
• Division of labor and specialization
• Invention of labor saving machinery
  (productivity)
• Improvements in transportation (markets)
• Invention, innovation and risk taking driven by
  the market
• Competition was the regulating invisible hand
• Movement of capital and response of
  population
• Automatic mechanism driving productivity and
  growth without governmental intervention
• All classes shared in the benefits of progress

9
The Boundaries of Progress

• Godwin human reason could solve all problems,
  potentially extending life indefinitely
• Malthus human passion would drive population to
  increase (geometrically) more rapidly than food
  supplies (arithmetically)

10
Utilitarianism

• Two masters pleasure and pain, contributing
  toward or diminishing happiness
• Measurable as positive or negative utility
• Public interest as the sum of private interests
• Introduction of economic models
• Law of Diminishing Returns

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Classical Economics Summarized

• Universal theories
• Free Trade (market forces)
• Utilitarianism
• Comparative Advantage
• Distinction between
• Science production, based on physical truths
• Values distribution of wealth, institutional
  issue
• Lists Caveat
• universal subjection of less advanced nations
• protection until competition on equal terms

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The Neoclassical Interlude

• Models (science) dominate
• Marginal Utility efficient allocation of
  resources at equilibrium
• Opportunity costs
• Pareto Optimality
• Given perfect competition, market forces allocate
  resources efficiently
• Minimize price, maximize utility
• Incomes commensurate with effort

13
Dynamic Analysis

• Unity of social and economic life
• Plurality of human motives
• Relativity of history
• Creative Destruction
• Productive innovations destroy old channels and
  create new ones
• Entrepreneurial will as a driving force
• Account for psychology and human motivation
• Innovative investment credit, not savings
• Business cycles
• Schumpeters Caveat
• Unfettered entrepreneurialism will foster
  socialism

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Keynesian Growth Theory

• Real investment
• Expectations, Risk
• Multiplier effect (spend/save ratio)
• Governmental stimulation
• Monetary policy
• Tax reduction
• Deficit spending
• Free markets did not always maximize human well
  being
• Goal policies to maintain full employment

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Harrod-Domar Model
Firms
Investment
Inflow
Wages, Profits, Rents
Consumption Expenditure
Outflow
Households
Savings
Figure 3. 1, page 52, Ray, Development Economics
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Harrod-Domar Model, cont.

• Household savings create sources of capital for
  investment (institutional implications)
• Investment in factors of production creates a
  demand for capital goods
• Which increases capacity for production
• Macroeconomic balance
• When Investment demand savings leakage

17
Development Economics

• Post WWII western economies focused on full
  employment
• Decolonialization
• Doctrinal competition (capitalism/communism)
• Institutions
• IMF, World Bank
• Top down extension of Keynesian principles to
  3rd World development
• Structuralist approach applied to specific
  conditions, rather than universal science
  applied to all economies
• trade theory recall Lists Caveat
• inflation causation
• End of January 3, Lecture