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Chapter
36
Economic Growth
in Developing
and Transitional Economies
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Growth
in Developing
and Transitional Economies
36
Chapter Outline
Life in the Developing Nations:
Population and Poverty
Economic Development: Sources and
Strategies
The Sources of Economic Development
Strategies for Economic Development
Growth versus Development: The Policy
Cycle
Issues in Economic Development
Population Growth
Developing-Country Debt Burdens
Economies in Transition
Political Systems and Economic Systems:
Socialism, Capitalism, and Communism
Central Planning versus the Market
The End of the Soviet Union
The Transition to a Market Economy
Six Basic Requirements for Successful
Transition
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC GROWTH IN DEVELOPING
AND TRANSITIONAL ECONOMIES
The same economic principles that have been
studied through the text apply to less-developed
countries.
Scarcity is universal
The economic problems facing the developing
countries are often quite different from those
confronting industrialized nations. The policy
options available to governments may also differ.
Nonetheless, the tools of economic analysis are
as
useful in understanding the economies of less
developed countries as in understanding the U.S.
economy.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Chapter 28
Figure 28-1
Life Expectancy and Incomes, 2000
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 36: Economic Growth in Developing
and Transitional Economies
LIFE IN THE DEVELOPING NATIONS:
POPULATION AND POVERTY
TABLE 20.1 Indicators of Economic Development
COUNTRY GROUP
POPULATION,
2004
GROSS
NATIONAL
INCOME
PER
CAPITA,
2004
(DOLLARS)
ANNUAL
HEALTH
EXPENDITURES
PER CAPITA
2004
(DOLLARS)
INFANT
MORTALITY,
2003
(DEATHS
BEFORE
AGE 5 PER
1,000
BIRTHS)
URBAN
POPULATION
(PERCENTAGE
OF TOTAL),
2002
Low-income
2.3 billion
510
29
122.0
30
Lower middle-income
2.4 billion
1,580
75
42.0
47
Upper middle-income
575.9 million
4,770
243
29.7
72
1.0 billion
32,040
2,977
7.0
76
High-income
Source: World Bank, www.worldbank.org
While the developed nations account for only about one-quarter of the world’s population,
they are estimated to consume three-quarters of the world’s output. This leaves the
developing countries with about three-fourths of the world’s people, but only one-fourth of
the world’s income. The simple result is that most of our planet’s population is poor.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
A. Economic Growth in Poor Countries
1. Human resources, natural resources, capital
formation, and technological advance are the four
driving forces of development. Less developed
countries typically have difficulty in exploiting all four.
2. Investments in the labor force (i.e., human capital)
are critical to economic development. While the other
factors of production can be imported if need be, labor
is homegrown. Education, training, health, and
Nutrition are vital to the development of this resource
and the economy.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
The United Nations has developed a
Human Development Index (HDI)
which combines four different
demographic, social, and economic
statistics: life expectancy at birth,
school enrollment, adult literacy, and
real GDP per capita. The relationship
between HDI and per capita output is
strong and positive for most
countries.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Chapter 28
Table 28-1
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Development: Sources and
Strategies
1. Economists have been trying to understand
economic growth and development since the
beginnings of the subject (Adam Smith and
David Ricardo).
2. The actual study of economic growth as it
applies to developing countries began after
World War II.
3. Economic development as a field of economics
asks one simple question: Why are some
countries poor while others are rich?
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
THE SOURCES OF ECONOMIC DEVELOPMENT
Capital Formation
vicious-circle-of-poverty hypothesis‫حلقة الفقر المفرغة‬
Suggests that poverty is self-perpetuating
because poor nations are unable to save
and invest enough to accumulate the capital
stock that would help them grow.
capital flight The tendency for both human
capital and financial capital to leave
developing countries in search of higher
rates of return elsewhere.
If the vicious circle hypothesis were universally true no nation would ever develop. Poverty
alone cannot explain capital shortages. Poverty is not necessarily self-perpetuating.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Chapter 28
Figure 28-3
The Vicious Cycle of Poverty
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
Human Resources and Entrepreneurial Ability
The brain drain is the tendency for talented people from
developing countries to become educated in a developed
country and remain there after graduation. The brain drain
siphons off many of the most talented minds from
developing countries.
Entrepreneurial activity also seems to be lacking.
Entrepreneurial activity is often discouraged by political and
economic systems that do not enforce property rights.
There is little incentive to be an entrepreneur if the state will
take the results of your success by force.
Development cannot proceed without human resources capable of initiating and managing
economic activity.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
Social Overhead Capital
social overhead capital
Also called infrastructure projects, includes
building roads, power generation systems, and
irrigation systems…...
Social overhead capital needs to be produced by
the government because the projects are too large
for the private sector.
The governments of developing countries can do important and useful things to encourage
development, but many of their efforts must be concentrated in areas that the private sector
would never touch. If government action in these realms is not forthcoming, economic
development may be curtailed by a lack of social overhead capital.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Development: Sources and Strategies
The Sources of Economic Development
Social Overhead Capital
Corruption
The following chart shows the
World Bank’s rating of
corruption levels in a number
of countries around the world.
The countries are ranked from
those with the strongest
controls on corruption—
Germany and France—to those
with the lowest controls—
Pakistan and Nigeria.
Indonesia, as you can see, is
near the bottom of the list.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
STRATEGIES FOR ECONOMIC DEVELOPMENT
Agriculture or Industry?
TABLE 20.2 The Structure of Production in Selected Developed and Developing Economies
2003
COUNTRY
PER-CAPITA
GROSS NATIONAL
INCOME (GNI)
PERCENTAGE OF GROSS DOMESTIC PRODUCT
AGRICULTURE
INDUSTRY
330
45
16
39
440
21
27
53
China
1,290
15
51
35
Colombia
2,000
13
0
87
Thailand
2,540
10
44
46
Brazil
3,090
5
17
78
Korea (Rep.)
13,980
3
35
62
United States
41,400
2
Japan
37,180
1
30
68
Tanzania
Bangladesh
$
SERVICES
Source: World Bank, www.worldbank.org, 2005.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
Exports or Import Substitution?
import substitution An industrial trade
strategy that favors developing local
industries that can manufacture goods
to replace imports.
Most economists believe that import
substitution strategies have failed
almost everywhere they have been tried.
Such policies have created major
economic inefficiencies, which limits
jobs.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
export promotion strategy
encourages development of local
industries that produce goods and
services for export. Export promotion
has seemed to result in higher rates of
growth. Japan, Hong Kong, Singapore,
Korea, and Taiwan have all pursued
such strategies fairly successfully.
Such strategies often include keeping
the exchange rate low so export prices
remain low.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
AND STRATEGIES
Central Planning or the Market?
a. The economic appeal of planning lies
theoretically in its ability to channel savings
into productive investment and to coordinate
economic activities that private actors in the
economy might not otherwise undertake.
b. The reality is that central planners rarely know
which sectors of the economy offer the highest
rates of return on investment.
c. The failure of many central planning efforts has
brought increasing calls for less government
intervention and more market orientation in
developing countries. These are frequently
recommended by the International Monetary
Fund and the World Bank
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
Central Planning or the Market?
International Monetary Fund (IMF) An
international agency whose primary goals
are to stabilize international exchange rates
and to lend money to countries that have
problems financing their international
transactions.
World Bank An international agency that
lends money to individual countries for
projects that promote economic
development.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Development: Sources and Strategies
Strategies for Economic Development
Microfinance: A New Idea
In the mid 1970s, Muhammad Yunus, a young
Bangladeshi economist created the Grameen
Bank in Bangladesh.
Microfinance is the practice of lending very
small amounts of money, with no collateral,
and accepting very small savings deposits. It
is aimed at introducing entrepreneurs in the
poorest parts of the developing world to the
capital market.
Relative to traditional bank loans, microfinance
loans are much smaller, repayment begins very
quickly, and the vast majority of the loans are
made to women (who, in many cases, have
been underserved by mainstream banks).
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIC DEVELOPMENT: SOURCES
AND STRATEGIES
GROWTH VERSUS DEVELOPMENT: THE POLICY
CYCLE
structural adjustment A series of
programs in developing nations designed to
(1) reduce the size of their public sectors
through privatization and/or expenditure
reductions, (2) decrease their budget
deficits, (3) control inflation, and (4)
encourage private saving and investment
through tax reform.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Development: Sources and Strategies
Growth versus Development: The Policy Cycle
Cell Phones Increase
Profits for Fishermen
in India
Kerala is a poor state in a region
of India.
Beginning in 1997 and continuing
for the next several years, mobile
phone service was introduced to this region of India.
Once the phones were introduced, waste, which had
averaged 5 to 8 percent of the total catch, was virtually
eliminated.
In fact, cell phones are improving the way markets in less
developed countries work by providing price and quantity
information so that both producers and consumers can
make better economic decisions.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Economic Development: Sources and Strategies
Two Examples of Development: China and India
China and India provide two interesting
examples of rapidly developing economies.
While low per- capita incomes still mean that
both countries are typically labeled developing
as opposed to developed countries, many
expect that to change in the near future.
Many commentators expect India and China to
dominate the world economy in the twenty-first
century.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ISSUES IN ECONOMIC DEVELOPMENT
POPULATION GROWTH
The Consequences of Rapid Population Growth
Rapid population growth is characteristic of many
developing countries. Large families can be
economically rational for parents who need support
in their old age, or because children offer an
important source of labor. However, having many
children does not mean a net benefit to society as a
whole. Rapid population growth can put a strain on
already overburdened public services such as
education and health.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
Population Growth
Population growth is a major problem for
developing countries.
a. In developing countries population growth
is 1.7 percent per year versus 0.5 percent
per year in the industrial market
economies.
b. At a growth rate of 1.7 percent per year
population will double from its 1990 level
by the year 2031. It will take the
industrialized countries 139 years to
double their population.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ISSUES IN ECONOMIC DEVELOPMENT
Causes of Rapid Population Growth
fertility rate The birth rate. Equal to (the
number of births per year divided by the
population) x 100.
mortality rate The death rate. Equal to
(the number of deaths per year divided by
the population) x 100.
natural rate of population increase The
difference between the birth rate and the
death rate. It does not take migration into
account.
Any nation that wants to slow its rate of population growth will probably find it necessary to
have in place economic incentives for fewer children as well as family planning programs.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ISSUES IN ECONOMIC DEVELOPMENT
DEVELOPING-COUNTRY DEBT BURDENS
debt rescheduling An agreement between
banks and borrowers through which a new
schedule of repayments of the debt is
negotiated; often some of the debt is written
off and the repayment period is extended.
stabilization program An agreement
between a borrower country and the
International Monetary Fund in which the
country agrees to revamp its economic
policies to provide incentives for higher
export earnings and lower imports.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIES IN TRANSITION
For 40 years, between the end of World War II and
the mid-1980s, a powerful rivalry existed between
the Soviet Union and the United States.
We reflect on historical political rivalries in an
economics text for two reasons.
• First, the 40-year struggle between the United
States and the Soviet Union was fundamentally a
struggle between two economic systems:
market-based capitalism (the U.S. system) and
centrally planned socialism (the Soviet system).
• Second, the Cold War ended so abruptly in the
late 1980s because the Soviet and Eastern
European economies virtually collapsed during
that period.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIES IN TRANSITION
POLITICAL SYSTEMS AND ECONOMIC SYSTEMS:
SOCIALISM, CAPITALISM, AND COMMUNISM
socialist economy An economy in which most
capital is owned by the government instead of
private citizens. Also called social ownership.
capitalist economy An economy in which
most capital is privately owned.
communism An economic system in which the
people control the means of production (capital
and land) directly, without the intervention of a
government or state.
Comparing economies today, the real distinction is between centrally planned socialism and
capitalism, not between capitalism and communism.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
ECONOMIES IN TRANSITION
CENTRAL PLANNING VERSUS THE MARKET
Just as there are no pure capitalist and no pure
socialist economies, there are no pure market
economies and no pure planned economies.
Generally, socialist economies favor central planning
over market allocation, while capitalist economies
rely to a much greater extent on the market.
Nonetheless, some variety exists.
market–socialist economy An economy
that combines government ownership with
market allocation.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE END OF THE SOVIET UNION
The Soviet Union grew rapidly through the mid1970s.
During the late 1950s, the Soviet Union’s economy
was growing much faster than that of the United
States. The key to early Soviet success was rapid
planned capital accumulation.
In the late 1970s, things began to deteriorate.
Dramatic reforms were finally introduced by Mikhail
Gorbachev after his rise to power in 1985.
Nonetheless, the Soviet economy collapsed in 1991.
The Soviet Union was dissolved, and the new
president of the Russian Republic, Boris Yeltsin, was
left to start the difficult task of transition to a market
system.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE TRANSITION TO A MARKET ECONOMY
SIX BASIC REQUIREMENTS FOR SUCCESSFUL
TRANSITION
Economists generally agree on six basic requirements
for a successful transition from socialism to a marketbased system:
(1) macroeconomic stabilization;
(2) deregulation of prices and liberalization of trade;
(3) privatization of state-owned enterprises and
development of new private industry;
(4) establishment of market-supporting institutions
such as property and contract laws, accounting
systems, and so forth;
(5) a social safety net to deal with unemployment and
poverty; and
(6) external assistance.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE TRANSITION TO A MARKET ECONOMY
Macroeconomic Stabilization
To achieve a properly functioning market system,
prices must be stabilized.
Deregulation of Prices and Liberalization of
Trade
An unregulated price mechanism ensures an efficient
allocation of resources across industries.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE TRANSITION TO A MARKET ECONOMY
Privatization
Private ownership provides a strong incentive for
efficient operation, innovation, and hard work that is
lacking when ownership is centralized and profits are
distributed to the people.
tragedy of commons The idea that collective
ownership may not provide the proper private
incentives for efficiency because individuals do
not bear the full costs of their own decisions but
do enjoy the full benefits.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE TRANSITION TO A MARKET ECONOMY
Market-Supporting Institutions
The capital market, which channels private saving
into productive capital investment in developed
capitalist economies, is made up of hundreds of
different institutions.
Social Safety Net
This social safety net might include unemployment
insurance, aid for the poor, and food and housing
assistance.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
THE TRANSITION TO A MARKET ECONOMY
External Assistance
Very few believe the transition to a market system
can be achieved without outside support and some
outside financing.
Shock Therapy or Gradualism?
shock therapy The approach to transition from
socialism to market capitalism that advocates
rapid deregulation of prices, liberalization of
trade, and privatization.
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CHAPTER 36: Economic Growth in Developing
and Transitional Economies
REVIEW TERMS AND CONCEPTS
brain drain
capital flight
capitalist economy
communism
debt rescheduling
export promotion
fertility rate
import substitution
International Monetary Fund
(IMF)
market–socialist economy
mortality rate
natural rate of population
increase
shock therapy
social overhead capital
socialist economy
stabilization program
structural adjustment
tragedy of commons
vicious-circle-of-poverty
hypothesis
World Bank
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