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Questions for Test 1
ECO 320 Economics of Development
Chapter 1
1.
Developing countries share some features (low levels of income, etc.), but they are
quite different in many respects. Explain what we mean by “institutions” and how is
it that developing countries different in institutional development. How would the
differences in the development of institutions make it more difficult to formulate
policies for development and theories of development?
2.
Is there a fixed set of prerequisites for development? Explain.
Chapter 2
3.
Comment on the following statement: The level and growth rate of real GDP per
capita can be a misleading indicator of development. At the same time, countries
that experience sustained increases in real GDP per capita over time will tend to be
more developed.
4.
Why is an understanding of what “development” means crucial to policy
formulation in developing nations? Why do you think a country may have
difficulties in agreeing on a rough definition of development?
5.
Why do we use “purchasing power parity” measures when comparing incomes
across countries?
6.
Suppose that you had to explain this graph to someone who is not a “visual learner”
– he just doesn’t get pictures. You have to explain every feature of the graph using
words.
7.
What are the components of the Human Development Index? What are some
strengths and weaknesses of the HDI as a comparative measure of human welfare?
8.
Discuss the Millennium Development Goals. How can the mere act of adopting
these goals as aims of action be beneficial for economic development?
Chapter 3
9.
What does it mean to say that “factor accumulation” and “productivity growth” are
important for development? How are they distinct?
10.
Most growth models assume that new investment increases the capital stock, that
investment is financed by saving, and that saving comes from income.
a. What is the role of depreciation in determining the level of capital stock in the
future? What can prevent investment from producing the desired amount of
capital?
b. What are the mechanisms (public, private) that can turn saving into
investment? What could prevent people’s savings from being invested
productively for the accumulation of new capital? What other uses could a
country give to people’s saving besides capital accumulation?
c. Besides income of domestic residents, from where else could saving come?
What are ways in which governments could get people to save more
(consume less) out of their income?
11.
12.
Explain this equation gY  WK  g K   1  WK   g L   a . What are the limits to
this approach to calculating the factors that contribute to economic growth?
An economy is characterized by the following figures. Calculate the economy’s
Total Factor Productivity growth rate.
gY
3.3%
gL
1.7%
gK
4.9%
WK
0.29
a
13.
Discuss the five characteristics of rapidly growing countries identified in the book.
14.
“Social and institutional innovations are as important for economic growth as
technological and scientific inventions and innovations. Effective institutions are as
important as technological efficiency.” What is meant by these statements? Explain
your answer.
15.
What does “convergence” mean? Which countries have “converged”?
16.
Why does agriculture decline as a share of GDP as the country becomes richer?
Why are increases in agricultural productivity necessary for structural change?
Chapter 4
17.
Suppose the capital-output ratio is 3, the depreciation rate of capital is 5% and the
gross savings rate is 15%.
a. Use the Harrod-Domar growth equation to determine the rate of growth.
b. What policies would have to be implemented to change the gross savings rate
to achieve 4% growth? What role could be played by foreign aid or private
capital inflows?
c. What policies would have to be implemented to change the capital-labor ratio
(keeping the gross saving rate constant) to achieve 4% growth?
18.
Suppose that all countries have the same rate of technological progress, the same
depreciation rate, and the same population growth rate. Also assume that the
1/ 3
production function in every country is y  f k   k
d. Use the production function to derive a formula for the ratio of GDP per
worker in the steady state that is predicted by the Solow model.
e. For each country pair below, calculate the ratio of GDP per worker in the
steady state that is predicted by the Solow model. Then calculate the actual
ratio of GDP per worker for each pair of countries.
For output per worker in 2005 (y), use the 2005 value for “GNI per capita,
PPP (current international $)” from the World Development Indicators. For
the Investment Rate (s), use the 1975-2003 average for “Gross capital
formation (% of GDP).”
Country
Investment
Rate (average
1960-2000)
Thailand
Bolivia
29.4%
10.1%
Country
Investment
Rate (average
1960-2000)
Nigeria
Turkey
7.5%
14.9%
Country
Investment
Rate (average
1960-2000)
Japan
New
Zeland
31.1%
21.0%
Ratio of y*
predicted
by Solow
model
Output per
Worker in
2000
Actual
ratio of y
Difference
between
predicted
and actual
Actual
ratio of y
Difference
between
predicted
and actual
Actual
ratio of y
Difference
between
predicted
and actual
$12,086
$7,152
Ratio of y*
predicted
by Solow
model
Output per
Worker in
2000
$1,906
$15,726
Ratio of y*
predicted
by Solow
model
Output per
Worker in
2000
$69,235
$40,176
f.
For which pairs of countries does the Solow model do a good job in
predicting relative income?
g. For which pairs does it do a poor job?
19.
20.
A country is described by the Solow model, with a production function of
y  f k   k 1/ 2 . Suppose that k is equal to 400. The fraction of output invested is
50%. The depreciation rate is 5%. Is the country as its steady-state level of outputper-worker, above the steady state, or below the steady state? Show how you
reached your conclusion.
In a country the production function is y  f k   k . The fraction of output
invested, s, is 0.25. The depreciation rate, d, is 0.05.
h. What are the steady-state levels of capital per worker, k, and output per
worker, y?
i. In year 1, the level of capital per worker is 16. In a table like the following
one, show how capital and output change over time (the beginning is filled in
as a demonstration). Continue this table up to year 8.
1/ 2
Year
1
2
3
4
5
6
7
8
Capital
Output
Investment
Depreciation
k
16
16.2
y k
sy
1
dk
0.8
4
Change in
Capital Stock
sy - dk
0.2
j.
Calculate the growth rate of output between years 1 and 2. Remember that a
growth rate of output is calculated as Yt  Yt 1  Yt 1 .
k. Calculate the growth rate of output between years 7 and 8.
l. How do the answers to parts c and d suggest “convergence”?
21.
Consider the article at the bottom of this document (from The Economist) about two
East Asian countries. Then answer the following questions.
a. How important is the assumption of a diminishing marginal product of
capital (as more capital is accumulated for given labor) in the conclusions of
the Solow growth model?
b. What evidence can we glean from Young's study about the empirical evidence
on diminishing returns?
c. One of Young's main points has to do with the allocation of capital in the two
countries. Singapore's capital has been largely allocated by the government
through its huge pension funds, to which all workers must contribute. In
Hong Kong, virtually all capital is privately allocated. Governments
sometimes have different objectives than private investors. To what extent can
this difference explain the difference in the rate of capital accumulation and
the productivity of capital in the two countries?
d. The article was written in 1992. Considering the following graph, do you
think that the article’s predictions have come true?
20%
15%
10%
5%
-5%
East Asian
financial crisis
-10%
Hong Kong, China
Singapore
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
89
19
88
19
87
19
86
19
85
19
84
19
83
19
82
19
81
0%
22.
In the Fei-Ranis model, the “traditional” sector (e.g., food) has many more workers
than it needs (it has a labor surplus) so it can reduce the number of workers without
reducing output (there’s “excess population”). This means that average wages are
very low, and the “modern” (e.g., manufacturing) sector can hire workers at low
wages, taking more workers out of the traditional as the modern sector expands.
e. As the modern sector hires more workers, the labor surplus becomes smaller.
What happens to wages in the modern sector when the labor surplus
disappears? What do you think will happen to modern production, profits,
and investment in the modern sector after that point?
f. What is likely to happen to wages in the country if the productivity of the
food sector improves, lowering food prices? Explain how that should help
industrialization.
Chapter 5
23.
What have we learned about the effects of imposing price and wage controls, of
deficit spending, trade tariffs, and subsidies?
24.
What have we learned about the effects of government regulation of markets and
privately owned industries?
25.
What have we learned about government use of fiscal vs. monetary policy in
promoting economic growth?
26.
Compare the benefits and drawbacks of nationalizing private enterprises and turning
them into state-owned industries.
27.
Compare the benefits and risks in re-privatizing state-owned industries.
WHERE HONG KONG HAS THE EDGE
Dateline: FROM OUR HONG KONG CORRESPONDENT
The Economist August 22, 1992
ONE of the most momentous and least understood events of this half-century is East
Asia's rise from poverty. The high rates of economic growth consistently achieved over
decades by the Asian tigers--Hong Kong, Singapore, Taiwan and South Korea--have
almost no equal anywhere at any time. Growth theory has trouble explaining this. The
difficulty is compounded by the wide divergence in circumstances and economic policies
of the four countries. Alwyn Young, a business professor at the Massachusetts Institute of
Technology, has written a paper* looking at how Hong Kong and Singapore did it. If his
analysis is right, it augurs ill for Singapore in the next decade or two.
Hong Kong and Singapore started on a similar footing in 1945. Both were city-states,
British colonies (with a British legal and administrative system) making their living as
trading ports. Neither manufactured much. Both were populated mainly with immigrants
from southern China.
In 1960 the two territories had roughly the same GDP per head, which over the following
quarter-century grew at an astonishing and virtually identical 6% a year in real terms.
Both were free traders, allowing foreign goods and money to flow where they would.
Both climbed the same industrial ladder, moving up from textiles to plastics to consumer
electronics to financial services.
There were two crucial differences. First, Hong Kong, its population luckily swollen by
sophisticated Shanghainese refugees from Communist China, had a vastly better educated
population than Singapore's until well into the 1980s. Second, Hong Kong had a laisserfaire government (to the point of not investing even in needed infrastructure until street
riots forced it to); Singapore had an extremely interventionist one.
The government decided which industries Singapore should go into and when. Through
its Central Provident Fund levies on companies and workers, it compelled private savings
of around 40% of GDP. Through state-owned companies and boards the government
channelled much of these savings, as well as its large excess of current tax revenues over
current spending, into investment it favoured. It welcomed, indeed heavily subsidised,
direct investment by foreign multinationals.
The sources of growth in the two territories turned out to be startlingly different. Between
1960 and 1985 Hong Kong saved and invested a more or less consistent 20% of GDP.
Singapore, which in 1960 invested half as much as Hong Kong, surpassed it in 1967 and
has invested a larger share ever since: by the late 1980s Singapore's investment as a share
of GDP was more than 40%, more than twice Hong Kong's rate.
In the two decades after 1970, Hong Kong's output per worker went up more than 2.5
times, Singapore's a little more than twofold. Not much difference there. However, Hong
Kong's output per unit of capital stayed roughly constant over the 20 years; Singapore's
was more than halved (see chart).
The alarm bells about Singapore's use (or misuse) of capital keep ringing louder. By the
mid-1980s Singapore's incremental capital-output ratio--meaning how much extra capital
was needed to produce an additional unit of output--was twice Hong Kong's. As you
would expect from an ever-increasing use of capital, Singapore's return on capital, which
in the early 1960s had been 40%, by the late 1980s had fallen to 11-12%, one of the
lowest rates in the world.
Most damning of all, Mr Young finds that over the two decades after 1970, 56% of Hong
Kong's increase in output per worker came from a rise in ``total factor productivity'' (how
much can be produced by combining given units of land, labour and capital). Singapore's
total factor productivity fell by 6% over those years: in other words, 106% of Singapore's
growth in output came from adding capital. To put it crudely, Hong Kong got richer by
becoming a lot more efficient in the way it used people, capital and technology.
Singapore became richer by thrusting its hands ever deeper into its citizens' pockets-through taxes, forced savings and subsidies to multinationals--and throwing the money at
the problem.
Economic-growth buffs will find it interesting that Hong Kong seemed to benefit so
much from the better education of its people. For Singapore, however, Mr Young's
analysis has a gruesome and more or less immediate practical implication. If he is right,
Singapore has very few years of growth left along the old lines: it simply cannot extract
much more savings from its people--already the biggest savers in the world--to support
its growing craving for capital. Mr Young's cruel comparison is to the Soviet Union,
which turned in respectable growth rates from the 1930s to the 1960s by pouring on the
capital. Everyone knows what happened after that.
*A tale of two cities: Factor accumalation and technical change in Hongkong and
Singapore", to be published in the "Macroeconomics Annual" (1992) of the National
Bureau of Economic Research.