Download McGraw-Hill/Irwin

Chapter 16
MACRO POLICIES IN
DEVELOPING COUNTRIES
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-2
Today’s lecture will:
• Examine some comparative statistics on rich
•
•
•
and poor countries.
Explain why there might be a difference in
normative goals between developing and
developed countries.
Discuss why economies at different stages in
development have different institutional needs.
Explain what is meant by the term dual
economy.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-3
Today’s lecture will:
• Distinguish between a regime change and a
•
•
•
policy change.
Explain why the statement that inflation is a
problem of central bank issuing too much
money is not sufficient for developing
countries.
Distinguish between convertibility on the
current account and full convertibility.
Identify seven obstacles facing developing
countries.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-4
Developing Countries
in Perspective
• Of the over 6.5 billion people in the world, 75%
live in developing countries.
• Per capita income in developing countries is
around $500 per year.
• Per capita income in the U.S. is about $40,000
per year.
• If purchasing power parity is used to make
income comparisons between countries, it’s as
if people in developing countries have twice as
much income as they had when the exchange
rate method is used.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-5
Statistics on Selected Developing, MiddleIncome, and Developed Countries, 2003
Daily
Calorie
Supply
Life
Expectancy
Infant
Mortality
(per 1000)
Developing
Ethiopia
Haiti
1803
1877
42
52
114
79
$ 100
380
Middle-Income
Brazil
Iran
3012
2898
69
69
33
34
2,710
2,000
Developed
Japan
U.S.
2782
3754
82
77
3
7
34,510
37,610
Country
McGraw-Hill/Irwin
GDP per
Capita ($)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-6
Growth versus Development
• Development refers to an increase in
productive capacity and output brought
about by a change in a country’s
underlying institutions.
 Development occurs through a change in the
production function.
• Growth refers to an increase in output
brought about by an increase in inputs,
given a production function.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-7
Differences Between Developed
and Developing Economies
• Different weighting of goals due to
differences in wealth.
 Developing countries face urgent needs, such
as food, shelter, and clothing.
• Differences in institutions.
 Political differences and laissez-faire
 Dual economy
 Fiscal systems
 Financial institutions
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-8
Political Differences
and Laissez-Faire
• Institutional checks and balances to
•
prevent government leaders using
government for their benefit often do
not exist in developing countries.
In these circumstances, economists
who would favor an activist
macroeconomic policy in a developed
country might favor laissez-faire
policies in developing countries.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-9
The Dual Economy
• A developing country’s economy is
•
usually a dual economy.
Dual economy – the existence of two
sectors:
 A traditional sector which does business in
local currency and produces in traditional
ways.
 An internationally oriented modern market
sector which is often indistinguishable from
a Western economy.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-10
Fiscal Structure of Developing
and Transitional Economies
• Discretionary fiscal policy is almost impossible
for developing economies.
 They don’t have the institutional structure necessary

to levy and collect taxes.
Many government expenditures are mandated by
political considerations.
• Developing countries may experience a regime
•
change, which is a change in the entire
atmosphere within which the government and
the economy interrelate.
A policy change is a change in one aspect of
government’s actions, such as monetary or
fiscal policy.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-11
Financial Institutions of Developing
and Transitional Economies
• Financial institutions in developing countries
•
•
•
are different from those in developed countries
because of the dual economy in developing
countries.
In the traditional economy the financial sector
is unsophisticated, with some trades made by
barter.
In the international economy, the financial
sector may be very advanced.
The dual nature of the financial sector imposes
constraints on monetary policy.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-12
Monetary Policy in
Developing Countries
• The primary goal of central banks in
•
•
developing countries is to keep the
economy running.
Central banks in developing countries
are generally less independent than ones
in developed countries.
Buying and selling foreign currencies in
order to stabilize the exchange rate is an
important function.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-13
Central Banks Are
Less Independent
• The central bank in a developing country
•
may have to print money to buy bonds to
keep its government running when it runs
a deficit.
They recognize that printing too much
money causes inflation, but they must
choose between inflation and the
consequences of not funding the
government deficit.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-14
Various Types of Convertibility
• Full convertibility – individuals may change
•
•
their currency into any currency they want for
whatever legal purpose they want.
Convertibility on the current account – a
system that allows people to exchange
currencies freely to buy goods and services,
but not assets in other countries.
Limited capital account convertibility – a
system that allows full current account
convertibility and partial capital account
convertibility.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-15
Various Types of Convertibility
• Because almost no developing country
•
•
has full convertibility, the international
part of the dual economy is dollarized.
Dollarized – contracts are framed in, and
accounting is handled in, dollars, not in
the home country’s currency.
Nonconvertibility makes international
trade more difficult.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-16
Various Types of Convertibility
• Exchange rate policy is an important
•
central bank function when the
developing country has partially
convertible exchange rates because
trade in the currency is thin – there are
not many buyers and sellers.
Exchange rate policy – buying and
selling foreign currencies in order to
stabilize the exchange rate.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-17
Conditionality and Balance
of Payments Constraints
• Developing countries often rely on advice from
•
•
the International Monetary Fund (IMF).
The IMF is a major source of temporary loans
to stabilize their currencies.
The basis for most IMF loans is conditionality
– the making of loans that are subject to
specific conditions, usually that deficits be
lowered and money supply growth be limited.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-18
Conditionality and Balance of
Payments Constraints
• A partially flexible exchange rate presents the
•
•
country with the balance of payments
constraint.
Balance of payments constraint – limitations
on expansionary domestic macroeconomic
policy due to a shortage of international
reserves.
Many developing countries borrow from the
IMF to meet both its domestic goals and its
balance of payments constraint.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-19
Obstacles to Economic
Development
• Political instability
• Corruption
• Lack of appropriate institutions
• Lack of investment
• Inappropriate education
• Overpopulation
• Health and disease
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-20
Political Instability
• Political instability closes off external and
•
•
internal sources of financial investment.
Foreign companies and wealthy citizens are
reluctant to invest when the government is
unstable creating a high risk of loss.
An unequal distribution of income contributes
to the instability because economic prospects
are so bleak that many people are willing to
support or join a guerilla insurgency.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-21
Corruption
• Developing countries often lack a
•
•
welldeveloped institutional setting and public
morality that condemns corruption.
As a result, bribery, graft, and corruption
are ways of life in most developing
countries.
Knowing that bribes must be paid
prevents many people from doing things
that would lead to growth.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-22
Lack of Appropriate Institutions
• Markets require the establishment of
•
•
property rights, which is a difficult
political process.
The existence of markets is meshed with
the cultural and social fabric of society.
Some of the cultural and social
institutions in developing countries may
not be conducive to growth.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-23
Lack of Investment
• Savings for investment can be generated
•
•
•
internally or brought in from outside the
country.
With very low per capita income, people in
developing countries aren’t able to save.
Savings from abroad is in the form of private
investment or aid from foreign governments.
Foreign aid amounts to about $11 per person in
developing countries.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-24
Foreign Investment
• Foreign businesses have a greater incentive to
invest in a country if that country has:
 A motivated, cheap workforce.
 A stable government supportive of business.
 Sufficient infrastructure investment.
 Raw materials that can be developed.
• Developing countries that have been
•
successful in attracting investment often get
further investment.
Economic takeoff – a stage when the
development process becomes self-sustaining.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-25
Inappropriate Education
• The right education is a necessary component
for growth.
• Often educational systems in developing
•
•
countries resemble Western educational
systems and may be irrelevant to growth.
Basic skills – reading, writing, and arithmeticare likely to be more conducive to economic
growth in developing countries.
Developing countries often experience a brain
drain – the outflow of the best and brightest
students from developing countries to
developed countries.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-26
Overpopulation
• Thomas Malthus predicted that population
would outrun the means of subsistence.
• Malthus’ prediction has been avoided in
developed countries.
• In many developing countries, however,
•
population growth has exceeded productivity
growth, leading to small or negative per capita
output growth.
Some developing nations have tried to limit
population growth by various means – from
advertising campaigns to forced sterilization.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-27
Health and Disease
• A country must have a reasonably healthy
•
•
population in order to develop economically.
Some diseases, such as AIDS and
tuberculosis, make it difficult to work and take
care of children.
Drug companies have very little incentive to
work on developing low-cost medicines to
treat diseases in developing countries because
the people are poor and can’t pay for the
drugs.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-28
Summary
• While policies in developed countries focus on
•
•
•
stability, developing countries struggle to
provide basic needs.
Development is an increase in productive
capacity and output brought about by a change
in underlying institutions.
Growth is an increase in output brought about
by an increase in inputs.
Many developing countries have dual
economies – one a traditional, nonmarket
economy, and the other an internationalized
market economy.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-29
Summary
• Rather than policy changes, most developing
•
•
countries need regime changes – changes in
the entire atmosphere within which the
government and the economy relate.
Central banks in most developing countries
lack independence and print too much money,
which causes inflation, but keeps the
government running.
Most developing countries have some type of
limited convertibility to limit the outflow of
saving.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-30
Summary
• Seven obstacles to economic
development are:
 Political instability
 Corruption
 Lack of appropriate institutions
 Lack of investment
 Inappropriate education
 Overpopulation
 Poor health and disease
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
16-31
Review Question 16-1 What is the dual economy in developing
countries?
A developing country has two sectors; a traditional economy that
uses the local currency and involves most of the population and an
internationally oriented modern market sector that resembles
Western economies. The international sector may use a foreign
currency and contracts governed by international law.
Review Question 16-2 What are seven problems of developing
economies?
Lack of investment, political instability, corruption, inappropriate
institutions, inappropriate education, overpopulation, and disease
and bad health
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.