Download Security Scenarios And The Global Economy

NS4053
Winter Term 2013
Theories of Economic Development
Trap Models, Vicious Circles
Economic Development Theories
•
•
•
•
Broad Classes of Theories
Stage Theories
•
Rostow – 5 stages
•
Bremer and Kasarda – failed take-off – New Second World
•
Porter – modern upgrading
•
Sachs – environmental settings
• World Economic Forum competitiveness stages (empirical section)
Trap Theories
•
Poverty Traps
•
Middle Income Trap
•
Vicious Circles
•
Balanced vs. Unbalanced Growth
• Big Push Theories
Sector/Dualism Models
•
Lewis – classical model
•
Fei-Ranis – two sector
2
Trap Models I
• Trap models cover a variety of situations.
• One set of problems involves starting growth in situations where
gradualism and incremental actions are unlikely to result in
permanent increases in income – poverty traps
•
•
•
•
•
•
• Another set of problems occur when growth comes up against
constraints that cause it to stall-out -- transition/growth traps
All countries possess growth enhancing factors and elements
that suppress growth.
Trap models assume that the growth suppressing forces
neutralize growth enhancing factors, so that a quantum shift in
policy is needed to start growth
Trap models often involve some sort of feed-back effect
enforcing the trap – vicious circle
Early models largely poverty traps.
As growth has stalled in some countries, newer transition gap
models developed
3
Trap Models II
• Early poverty trap models assumed rapid rates of
population growth, peaking out at some biological
maximum.
• If the rate of growth of population exceeds that of the
economy – forces per-capita income down to low level –
growth may be slow because of potential savings used to
raise children rather than flow into investment
• For increases in per-capita income to be sustained to reach
higher standards of living, need to have rapid growth above
that of the population – once occurs savings flows into
investment
4
Trap Models III
• More recent poverty trap models focus on situations
whereby an individual, a group of households, a
country or geographic region occupies a stable
equilibrium at a low level of wealth and output
• Have provided one rational for foreign aid programs
and were the impious for the UN’s Millennium project
• Many of the newer models follow Sachs’ research in
Africa
• Substantial level of foreign aid over an adequate time
frame raise capital stock and contribute to growth
• Raises households out of poverty
• Growth cumulative as households saved and public
investments were facilitated by household taxation
• Research has shown that aid has not generated the
big growth effects anticipated by the existence of
5
poverty traps.
Trap Models IV
• Easterly, formerly with the World bank found:
• Growth is lower in aid-intensive countries than in developing
countries that get little aid
• Aid has risen over time as a percent of income in Africa, but
Africa’s growth rate has fallen over time
• The difference in growth rates between the poorest one fifth of
countries in 1950 and the others ranked by per-caita income
over time to 2001 was not statistically significant
• Countries that filed to grow within the poorest group – Chad,
DRC – were offset by those that did grow – Botswana, Lesotho,
China, India
• Easterly also finds no evidence for the poverty trap
based on the assumptions of:
• A lower growth rate for the poorest countries and
• A per-capita growth rate of zero in the poorest countries
6
Trap Models V
• Easterly statistical findings on poverty trap
• No statistical difference between the growth rate of the
poorest 20%, 1.9% and others over 1950-75 period
• Similar for 1975-2001 and 1980-2001 periods
• Data from 1985 suggest poorest countries have fared
worse, but comes at a time when poorest countries were
getting more foreign aid as % of their incomes.
7
Trap Models VI
• In sum, evidence for poverty traps based on an
income criteria is easily refuted
• Still no denying that some countries remain poor
while others become richer
• The scenario of a widening income disparity over time
between poorer and richer countries is another form
of poverty trap – a divergence trap
• What maintains the inequality trap?
• Insufficient savings as suggested by the poverty trap or
• An institutional poverty trap
• Current thinking:
• countries with sound institutional frameworks – property rights,
sound legal system experience higher rates of growth
• also that higher rates of growth is good for poverty reduction
8
Trap Models VII
Importance of institutions:
• The effectiveness of public policies designed to encourage
capital accumulation, knowledge and technological creation
depend on underlying institutions
• Right institutions can provide incentives for economic
growth
• Clearly a reward structure that provides incentives for
individuals and corporations to undertake investments in
new technology and human capital that are necessary for
growth
• The political system – authoritarian or participatory –
creates different types of reward structure with the latter
found to provide a growth-promoting cluster of institutions
• Governments that do not provide a reward structure – often
corrupt and oversee a system of weak institutions.
• Easterly attributes the unsatisfactory growth record of the
poorest countries to having “more to do with awful
9
government than with a poverty trap.”
Middle Income Trap I
• The middle-income trap refers to situation whereby a
middle-income country is failing to transition to a
high-income economy
• Rising costs
• Declining competitiveness
• Few countries successfully manage the transition from
low to middle to high income
• Many countries in Latin America and Middle East
regions have been stuck in this middle income trap
• Struggling to remain competitive as high volume, low
cost producers in the fact of rising wage costs
• The hallmarks of success become the binding
constraints for these countries
• Evidence to support the middle-income trap indicates
a leveling off of income per capita and a decline or 10
stagnation in an economy’s competitiveness
Middle Income Trap II
• Korea, Brazil, Philippines and Syria took off in growth from
the mid 1970s.
• Korea continued to growth through the 1980s, achieving
almost $8,000 per capita income in 2006
• The other countries leveled off over the period.
11
Middle Income Trap III
• Malaysia, Thailand, Indonesia and Philippines all
experienced stagnation in global competitiveness over
period to 2009
12
Middle Income Trap IV
•
Research at the World Bank identifies two key ingredients that
comprise a number of others:
• High levels of investment that embody new technologies
•
•
•
•
•
• Innovation-conducive policies
Investment levels of 25% of GDP or more are needed to achieve
strong growth
Investment rates in Korea and Japan have averaged 31% since
their respective takeoffs in 1978 and 1950
Transitioning to a high-growth economy requires a move up the
value chain
Innovation in new products and processes both in adoption and
development as well as business operation is critical
A good innovation policy requires
• Creating incentives for productive entrepreneurship
• Providing adequate skills to the workforce
• Ensuring good transmission of information and ideas; and
• Making sure that financing is available for start-ups, upgrades and
commercialization
13
Vicious Circle Models: I
• A variant of the trap models entails vicious circles
• Theory indicates that poverty perpetuates itself in mutually
reinforcing vicious circles on both the supply and demand side
• Supply Side
• Because incomes are low, consumption cannot be diverted
from capital formation
• Lack of capital results in low productivity which perpetuates
low income
• A country is poor because it was previously too poor to save
and invest.
• Demand Side
• Because incomes are low market size (for many consumer
goods) is too small to encourage investors
• Lack of investment leads to low productivity and continued low
income
• A country is poor because it was previously too poor to provide
the market to spur investment
14
Vicious Circle Models II
• Critique – Insufficient Savings
• Vicious circle seems plausible to those who imagine the
entire population is poor and hungry – surprised anyone
saves
• Reason to believe developing populations can save
substantially more than they do.
• Highest income groups often live far above subsistence
levels
• India’s richest 10 percent receive about 34 percent of
national income – amount per head nine to ten times that of
the poorest 10 percent
• Evidence indicates that consumption levels are determined
less by absolute income than by relative income (income in
comparison to neighbors and community members)
• Thus richer income classes could save considerably if they
were sufficiently motivated.
15
Vicious Circle Models III
• One reason may not do so is because of the demonstration
effect of consumption levels in the West and of elites in
their own countries
• Still personal savings is usually a small proportion of
developing country savings
• Corporate saving, government saving, public enterprise
profits, social security premiums, and the like may be other
sources of saving
• Always seems to be plenty of money for waging war
• Critique: Small Markets
• Fact is many markets are ample for using modern
production methods – sugar mills, textiles etc
• Studies have found that “economies of experience” are
more important for large-scale production than economies
of scale from increased market size.
• As with trap models, modern vicious circle models usually
incorporate some type of institutional failure as responsible for16
stagnation
Vicious Circle Models IV
17
Vicious Circle Models V
18
Vicious Circles: Iraq Case Study I
• Many of the economic/social/political forces in Iraq are
interrelated. The key to growth is to draw on these
compatibilities and create an environment in which each
builds on the other. To accomplish this:
• The economic reform process needs to be deepened and
completed.
•
•
•
•
•
Major improvements in governance are essential.
Oil production needs to expand to 2.5 - 3.0 million b/d.
The political environment must become encompassing.
There needs to be a more equitable direct sharing of oil revenues.
Macroeconomic stability must be maintained with inflation at 1015%.
• Corruption levels must begin declining.
• The provinces must gain greater control over their funding.
19
Vicious Circles: Iraq Case Study II
• A number of key components can work together to create
virtuous circles of growth and institutional development:
• Infrastructure programs create critical imbalances that stimulate
follow-on private sector investment, thus making decision-making
easier and reduce the uncertainty over future costs.
• Encouraging Iraq’s entrepreneurial talent promotes the dual-track
policy of stimulating the formation of new small- and mediumsized enterprises (SMEs), while drawing informal economy firms
into the formal economy.
• This, in turn, leads to maximum job creation and genuine
economic progress, thus weakening the pull of the insurgency.
• Price reforms remove many of the incentives to revert to the
shadow economy and, in turn, facilitate anti-corruption campaigns.
• With reduced insurgency and corruption, private investors
respond to the investment opportunities created by the
infrastructure program.
The Future: Virtuous Circle II
• Maintenance of improved macroeconomic stability facilitates
development of market-based financial instruments, allowing the
Central Bank of Iraq to gain better control of monetary and credit
policy.
• Banking system reforms in a stable macroeconomic environment
lead to increased funding of small and medium sized enterprises
– Track II SMEs .
• Possible direct distribution of oil revenues helps develop
domestic markets, thus creating real demand for new and
growing enterprises.
• New firms, workers, and a large portion of the population have a
stake in moving the reform process ahead.
• Expanded reforms reduce corruption and improve the regulatory
climate – perhaps slowing or reversing the brain drain.
• With improved governance comes higher economic growth and
the stimulus for further expansion.
Vicious Circles: Iraq Case Study III
Vicious Circles: Iraq Case Study IV
• Critical intangibles likely to influence Iraq’s future
economy include:
• The extent to which economic progress can be made without a
significant reduction in corruption
• The speed and degree to which trust can be restored
• The ability of the financial system to play a significant role in
private sector investment
• The extent to which a growing economy and expanding job
creation can undermine the insurgency.
• The level to which religious influences are likely to mold the
country’s economic institutions and whether they will make the
movement to a liberal market economy more difficult
• The extent to which the Iraqi government can evolve into a
development state – a democratic version of the 1970s regime.
• The effectiveness of CERP, PRT and other programs in creating
viable and dynamic economic activity at the local level.
Contrasting Views
• “If I am permitted to dream, Iraq will develop into the Japan of
the Middle East.”
• Talib al-Tabatie, Chairman, Iraq Stock Exchange
• “It seems that many Iraqis do not understand…why a market
economy can make the poor people much better off than they
ever were when Saddam controlled the oil wealth and doled
out perks to the Iraqis like a stern parent rewards small
children for being seen and not heard.”
• Ronald Rotunda – George Mason University Foundation
Professor of Law.
• “We want to go back to the old healthy management of the
1970s.
• Thamir Ghadhban – Oil Minister, Iraqi Interim Government
Balanced/Unbalanced Growth I
• Many contemporary disputes repeat themes from midtwentieth-century debates, balanced growth versus
unbalanced growth
• Sometimes the debate is semantic – what is balance?
• Rigid formula with all sectors growing at same rate?
• More flexible that some attention be given to all major sectors?
• Other issues in the debates
• What are the relative merits of strategies of gradualism vs. a big
push?
• Is capital or entrepreneurship the major limitation to growth?
25
Balanced/Unbalanced Growth II
• Balanced growth
• Synchronized application of capital to a wide range of
different industries
• One way of escaping from the vicious circle of poverty
• Early theories were pessimistic about exports, so usually
applied to sectors of the domestic economy
• Big Push Thesis
• Advocates of synchronized application of capital to all major
sectors support the big push thesis
• Argue a strategy of gradualism is domed failure
• Substantial effort is essential to overcome the inertia
inherent in a stagnant economy
• Analogy to a car being stuck in snow – will not move with a
gradually increasing push – needs a big push
• Led Tony Blair to call for a big, big push forward in Africa
26
Balanced/Unbalanced Growth III
•
•
•
•
•
Early versions based on idea that the factors that contribute to
growth like demand and investment in infrastructure do not
increase smoothly, but are subject to sizable jumps or
indivisibilities
Indivisibilities result from flaws created in investment market by
external economies
Cost advantages rendered free by one producer to another
These benefits spill over to society as a whole or to some member
of it rather than the investor concerned.
Example – increased production from investment in the steel
industry will benefit other industries as well
• Greater output stimulates demand for iron, coal and transport
• Lower costs may make vehicles and aluminum cheaper
•
•
• Other industries may benefit later by hiring laborers who acquired skills
in the mills
Thus the social profitability of this investment exceeds its private
profitability –
Unless government intervenes, total private investment will be too
27
low
Balanced/Unbalanced Growth III
•
Indivisibility in Infrastructure:
• Need whole system – cannot increase incrementally
•
• Can’t build a smaller Aswan Dam or shorter Monterrey-Mexico City
telegraph line
Indivisibility in demand
• Arises from the interdependence of investment decisions Prospective
investors uncertain whether output from project will find a market
• The workers in an individual project will not buy all of that product
• However investment in a wide variety of industries will create enough
purchasing power to buy the available increase in supply
• Return on individual project may be 5% with high uncertainty.
• Investment on a broad front increased return to 15% with greater certainty
• What is not true for the individual factory is true for the complementary
system of many enterprises
• The new producers are each other’s customers and create additional
markets through increased incomes
• Complementary demand reduces risk of not finding a market increases
incentive to invest
28
Balanced/Unbalanced Growth IV
• Possible Examples
• Situations today where world trade is costly – landlocked
countries like Bolivia
• Domestic agriculture or exports may not be sufficient for
industrialization
• So economies need large domestic markets
• Historic examples:
• Colombia’s tobacco export boom failed to lead to widespread economic
development as incomes went to a few plantation owners who spent on
luxury imorts
• Later from 1880-1915 boom in coffee exports, grown on small family
enterprises benefited large numbers who demanded domestic
manufacturers
• For industrialization, incomes from the leading sector must
be broadly distributed, providing demand for
manufacturing.
29
Balanced/Unbalanced Growth V
• Critique Balanced Growth
• Advocated of balanced growth emphasize a varied
package of industrial investment often at the expense
of investment in agriculture
• Comparative advantage suggests that a country
cannot grow rapidly if it fails to specialize where
production is most efficient
• Recent experience of developing countries suggests
they cannot neglect agricultural investment if they
are:
• to feed their populations,
• supply industrial inputs and
• earn foreign currency
30
Balanced/Unbalanced Growth VI
• Critique Balanced Growth cont.:
• Infrastructure is not as indivisible as advocates imply.
• Roads, rivers, canals, or air traffic can substitute for
railroads
• Roads my be dirt, graveled or paved and various widths
• Power plants can differ greatly in size. Controversy in Iraq
over state of art power grids or small generators
• Large infrasture facilities, although perhaps economical at
high leves of development are not essential for growth
• Resources required for carrying out strategy vast
• If country had these resources, probably wouldn’t be
undeveloped
• Where will country obtain the capital, skilled labor and
materials needed for such an expansion
• Although new industries may be complementary on the
demand side, they are competitors for limited resources on
31
the supply side.
Balanced/Unbalanced Growth VII
• Advocates of balanced growth often assume the country
starts from scratch
• In reality every country starts from a position that reflects
previous investment decisions
• Thus at any time there are highly desirable investment programs
that are not balanced in themselves but are well integrated with
existing capital imbalances
• The strategy was tarnished by the widespread evidence
that developing countries have grown rapidly without any
attempt at massive investments in the wide range of
industries that advocates considered essential
32
Balanced/Unbalanced Growth VIII
• Hirschman’s strategy of imbalance
• Part of economic strategy for Iraqi reconstruction
• Idea that unbalanced investment to complement existing
imbalances.
• He contends that deliberately unbalancing the economy, in
line with a predesigned strategy is the best path for growth
• Argues that the big push thesis may make interesting
reading for economists, but most countries don’t have the
skills or resources needed to launch such a massive effort
• The major shortage in most developing countries is not the
supply of savings but the decision to invest by
entrepreneurs, the risk takers and decision makers
• Hirschman believes poor countries need a development
strategy that spurs investment decisions.
• He suggests that because resources and abilities are
limited, a big push is sensible only in strategically selected
industries
33
Balanced/Unbalanced Growth IX
• Hirschman’s Intentional Unbalancing Strategy
34
Balanced/Unbalanced Growth X
• Growth then spreads from one sector to another – similar
to Rostow’s concept of leading and following sectors
• While Unbalanced Growth advocates usually stress the
advantages of free markets, they often restrict this to
areas outside of investment
• Example – Profitability of projects a function of the order
in which they are taken
• Truck factory = return of 10% and steel factory 8%
• If interest rate is 9% then invest in truck factory
• Later as a result of this investment returns on the steel factory
increase to 10% so investment then in that industry
35
Balanced/Unbalanced Growth XI
• Or might get situation where:
• Establishing a steel factory would increase the returns in
the truck factory from 10% to 16%
• Society would be better off investing in the steel sector
first and the truck enterprise second rather than making
independent decisions based on the market
• Planners need to consider the interdependence of
investment projects so that they maximize overall social
profitability
• Need to make the investment that spurs the greatest
amount of new investment decisions
• Investments should occur in industries that have the
greatest linkages including backward and forward
linkages
36
Balanced/Unbalanced Growth XII
• Criticisms of unbalanced growth strategy
• As in balanced growth case, many types of
infrastructure – may be cheaper to have smaller
projects utilized fully than large projects that are
underutilized – white elephants
• Assumes that there is a lack of decision making in the
private sector, but that the government has no trouble
in this regard
• Japan grew through the reverse mechanism – entrepreneurs
invested and then pressured the government to alleviate
bottlenecks
• However Mexico after the Revolution in the early 1900s found
government unbalancing accelerated growth
• Often not as clear cut where the greatest shortage of decision
making lies – public or private sectors.
• Eventually both strategies lead to balance
37