Download History, Expectations and Development

HISTORY, EXPECTATIONS AND
DEVELOPMENT
THE QUESTION:
Theory and evidence reviewed so far indicate that
the level and growth of GDP depends on savings
(investment) rates and that, conditional on (s, n)
countries converge to the same growth rate
 But then what determines the saving
(investment) rate? What if it depends on the past
history of a country? What is the role of
expectations about the future?

HISTORY AND EXPECTATIONS WORK
THROUGH TWO CHANNELS:

Complementarities

Increasing Returns
COMPLEMENTARITIES

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Complementarities are a special kind of
externalities. They happen when the cost of an
action is lower (or the benefit is higher) if many
agents are undertaking the same action.
Examples: Qwerty vs. Dvorak; XBox vs. PSII
COMPLEMENTARITIES HAVE 3 IMPORTANT
CONSEQUENCES:

There can be multiple equilibria

History matters

Short-lived policy interventions can have long
lasting effects
MULTIPLE EQUILIBRIA -1
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Assume Nintendo come up with a new console,
clearly better than the PSII,
With complementarities, the cost of using either
console depends on how many other people are
using it.
We can have 2 equilibria: everybody buys N,
everybody buys PSII.
Note that “everybody buys PSII” is a “worse”
equilibrium. However, due to complementarities
it is rational for each consumer to buy PSII when
everybody else is doing so.
MULTIPLE EQUILIBRIA -2-
HISOTY MATTERS

The equilibrium reached by the economy depends
on its initial conditions, in the example above, the
fact that many consumers are purchasing PSII
before the introduction of N, makes it more likely
that the economy ends up in the equilibrium
where everybody sticks with PSII even if N is
better
SHORT-LIVED POLICIES CAN HAVE A LONG
LASTING EFFECT


Assume Nintendo sells games cheap enough to
overcome the complementarity effect (in the
graph AC curve for N shifts down “enough”). This
will make each consumer want to shift regardless
of what everybody else is doing. Once enough
people have shifted to N, the equilibrium is selfsustaining – i.e. Nintendo can stop the sale
The fact that externalities take the form of
complementarities plays a key role
COMPLEMENTARITIES & ECONOMIC
DEVELOPMENT: MICRO ISSUES


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Complementarities arise in many circumstances – they are
particularly important for the adoption of new technologies,
Rethink of the example above in terms of crops varieties
instead of game consoless,
Namely farmers can choose between traditional staple crop
and a new cash crop,
Complementarities arise for several reasons: information
sharing, marketing costs..
The example illustrates that the new cash crop will not
necessarily be adopted, even if it is more profitable than
the traditional staple crops
COMPLEMENTARITIES & ECONOMIC
DEVELOPMENT: MACRO ISSUES -1

Idea: Coordination Failure (Rosenstein – Rodan)
Assume all production must be sold within a
country. Compare two industrialisation paths:
Huge shoe factory, employing all workers => not
sustainable: all income needed to be spent on shoes.
 Divide resources into shoe, cloth and food factories =>
is sustainable


Profitablity of each industry depends on the other
existing (and paying wages) => jointly viable
COMPLEMENTARITIES & ECONOMIC
DEVELOPMENT: MACRO ISSUES -2
Need for Coordination: Every entrepreneur
invests if he thinks others will
Multiple equilibria
 History matters



Complementarities in investment can lead
similar economies to very different equilibria.
Endogenous growth model with externalities in
capital accumulation
A RELATED CONCEPT: LINKAGES


Industries are connected not only through the
demand for final products, but also through input
markets
Example
A POLICY ALTERNATIVE

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Activate Links – Less costly and lower
information requirement
Which Sectors?
Sectors with many strong links, preferable backward
 Sectors that are least profitable for private investors
(eg. Railways)
