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CHAPTER 20
ECONOMIC DEVELOPMENT
In this chapter, you will find:
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Answers to the End-of-Book Questions and Problems for Chapter 20
Supplemental Cases, Exercises, and Problems
INTRODUCTION
This chapter examines differences between developing and industrial economies. After comparing
conditions across nations such as health and nutrition, birth rates, and the role of women, as well as their
implications for economic growth, the chapter moves to the role of productivity in a nation’s economic
vitality. The importance, and problems, of international trade to developing countries is discussed, along
with the benefits and problems associated with foreign aid. The chapter closes with a look at transitional
economies and the markets and institutions necessary for their success.
LEARNING OUTCOMES
1
Describe the worldwide variation in economic vitality
The most common measure of comparison of standards of living between different countries is output per capita.
Developing countries are distinguished by low output per capita, poor health and nutrition, high fertility rates,
poor education, and saving rates that are usually too low to finance sufficient investment in human and physical
capital.
2
Explain why productivity is the key to development
Labor productivity, measured in terms of output per worker, is by definition low in low-income countries, as it
depends on the quality of the labor and other inputs that combine with labor, such as capital and natural resources. The key to a rising standard of living is increased productivity. To foster productivity, developing nations must stimulate investment, support education and training programs, provide sufficient infrastructure, and
foster supportive rules of the game
3
Discuss international trade and development
Developing countries need to trade with developed countries to acquire the capital and technology that will increase labor productivity. Exports usually generate more than half of the annual flow of foreign exchange in
developing countries. Foreign aid and private investment make up the rest. Developing countries often use either
import substitution or export promotion strategies to improve production. With import substitution domestic
manufacturers make products that had previously been imported and the government supports them with tariffs
and quotas. Export promotion concentrates on producing for the export market. Export promotion has proven
generally more successful.
4
Describe the role of foreign aid in economic development
Foreign aid has been a mixed blessing for most developing countries. In some cases, that aid has helped countries build the roads, bridges, schools, and other capital infrastructure necessary for development. In other cases,
foreign aid has simply increased consumption and insulated government from painful but necessary reforms.
Worse still, subsidized food from abroad has undermined domestic agriculture, hurting poor farmers.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-3 FOR THE FOLLOWING SECTION
Worlds Apart
 Output per capita, or the amount an economy produces per capita, compares living standards across
nations.
 The World Bank classifies countries by gross national income (GNI ), the market value of all goods
and services produced by resources supplied by the countries’ residents and firms, regardless of the
location of the resources.
USE POWERPOINT SLIDES 4-12 FOR THE FOLLOWING SECTION
Developing and Industrial Economies
 Developing Countries: Low- and middle-income economies
 Industrial Market Countries: High-income economies
Health and Nutrition: Differences in stages of development among countries are reflected in a number of
ways besides per capita income.
 Malnutrition: A primary factor in more than half of the deaths of children under five in low-income
countries.
 Infant Mortality: Child mortality rates are much greater in low-income countries than in high-income
countries.
High Birth Rates: The birth rate is one of the clearest ways of distinguishing between industrial and
developing countries.
Women in Developing Countries: Poverty is greater among women than men, particularly women who
head households.
USE POWERPOINT SLIDES 13-26 FOR THE FOLLOWING SECTION
Productivity: Key to Development
Low Labor Productivity: Labor productivity, measured in terms of output per worker, is by definition
low in low-income countries.
Technology and Education: If knowledge is lacking, resources may not be used efficiently; and people
may be less receptive to new ideas and methods.
Inefficient Use of Labor: Unemployment and underemployment reflect inefficient uses of labor.
 Underemployment: Occurs when skilled workers are employed in low-skill jobs or when people are
working less than they would like.
Natural Resources: An abundant supply of a natural resource is not in itself enough to create a modern
industrial economy.
Financial Institutions: Some developing countries’ central banks finance public outlays by printing
money, so high and unpredictable inflation discourages saving and hurts development.
Capital Infrastructure: Production and exchange depend on a reliable infrastructure of transportation,
communication, sanitation, and electricity.
Entrepreneurial Ability: Unless a country has entrepreneurs who are able to bring together resources and
take the risk of profit or loss, development may never get off the ground.
Rules of the Game: The most elusive ingredients for development are the formal and informal institutions
that promote production and exchange: the laws, customs, conventions, and other institutional elements
that sustain an economy.
 Social Capital: Consists of shared values and trust that promote cooperation in the economy.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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USE POWERPOINT SLIDE 27 FOR THE FOLLOWING SECTION
Income Distribution Within Countries: The share of national income going to the poorest fifth of the
population was less evenly distributed in low- and middle-income countries than in high-income countries.
USE POWERPOINT SLIDES 28-31 FOR THE FOLLOWING SECTION
International Trade and Development
Trade Problems for Developing Countries: About half of merchandise exports from low-income
countries consist of raw materials whose prices fluctuate more widely than the prices of finished goods.
Trade deficits in developing countries often cause restrictions on imports of capital goods needed to
promote long-term growth and productivity.
Migration and the Brain Drain: Often the best and brightest professionals, such as doctors, nurses, and
engineers migrate to developed countries.
Import Substitution Versus Export Promotion
 Import Substitution: Domestic manufacturers now make products that have previously been
imported.
 Export Promotion: Concentrates on producing for the export market.
Trade Liberalization and Special Interests: Gains from economic development are widespread, but
beneficiaries do not recognize their potential gains. Losers tend to be concentrated and know quite well the
sources of their losses, so government often lacks the political will and support to remove impediments to
development.
USE POWERPOINT SLIDES 32-38 FOR THE FOLLOWING SECTION
Foreign Aid and Economic Development
 Foreign Aid: Any international transfer made on concessional (i.e., especially favorable) terms for the
purposes of promoting economic development.
Does Foreign Aid Promote Economic Development? Foreign aid may raise the standard of living in
some developing countries, but it has not necessarily increased the ability to become self-supporting at that
higher standard of living.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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CHAPTER SUMMARY
Developing countries are distinguished by low output per capita, poor health and nutrition, high fertility
rates, poor education, and saving rates that are usually too low to finance sufficient investment in human
and physical capital.
Worker productivity is low in developing countries because the stocks of human and physical capital are
low, technological advances are not widely diffused throughout the economy, entrepreneurial ability is
scarce, financial markets are not well developed, some talented professionals migrate to high-income
countries, formal and informal institutions do not provide sufficient incentives for market activity, and
governments may serve the interests of the group in power rather than the public interest.
The key to a rising standard of living is increased productivity. To foster productivity, developing nations
must stimulate investment, support education and training programs, provide sufficient infrastructure, and
foster supportive rules of the game.
Increases in productivity do not occur without prior saving, but low incomes in developing countries offer
less opportunity to save. Even if some higher-income people have the money to save, financial institutions
in developing countries are not well developed, and savings are often sent abroad where there is a more
stable investment climate.
Import substitution is a development strategy that emphasizes domestic production of goods that are
currently imported. Export promotion concentrates on producing for the export market. Over the years,
export promotion has been more successful than import substitution because it relies on specialization and
comparative advantage.
Foreign aid has been a mixed blessing for most developing countries. In some cases, that aid has helped
countries build the roads, bridges, schools, and other capital infrastructure necessary for development. In
other cases, foreign aid has simply increased consumption and insulated government from painful but
necessary reforms. Worse still, subsidized food from abroad has undermined domestic agriculture, hurting
poor farmers.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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TEACHING POINTS
1. Students can usually relate to the material presented in this chapter because many of the events in
question have occurred within their learning spans, i.e., since 1989. It is helpful to encourage student
participation in discussing the differences between developing and industrial economies. Indeed,
since there are often many students from developing nations in college classes, it is easy to talk about
topics such as health and nutrition, women’s roles, and technology and education in developing
economies.
2. Students generally find that trade problems for developing nations are intuitive and easy-tounderstand, and students are often able to give personal examples of brain drain. Lively class discussions often occur with the topic of foreign aid; students may have very strong opinions on this topic.
You might want to keep the discussion on track by talking about the connections between foreign aid
and economic development.
3. It is more challenging to discuss the institutions critical to a market economy. You will want to remind students of the institutions, or “rules of the game,” and then discuss with the class the problems
that result when institutions are weak or absent.
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1 (Worlds Apart) GNI per capita income most recently was about 158 times greater in the United States
than in the Congo. Suppose GNI per capita grows an average of 3 percent per year in the richest
country and 6 percent per year in the poorer country. Assuming such growth rates continue
indefinitely into the future, how many years would it take before per capita in the Congo exceeds
that of the United States? (To simplify the math, suppose at the outset per capita income is $158,000
in the richer country and $1,000 in the poorer country.)
To solve this problem, you must be able to use the compound growth function on a personal
calculator and employ trial and error to reach a solution. For example, you might start with the
results for the first 100 years, then add or subtract years depending on your findings. Based on
compound annual growth, the poorest country growing at 6 percent per year will pass the richest
country growing at 3 percent per year in about 177 years and will have a per capita income of $30.1
million per year.
2.1
(Import Substitution Versus Export Promotion) Explain why domestic producers who supply a good
that competes with imports would prefer an import-substitution approach to trade policy rather than
an export-promotion approach. Which policy would domestic consumers prefer and why?
Domestic producers would rather not face competition from imports, so they would prefer a trade
policy that outlaws imports. Such an approach tends to increase the price and the profit of domestic
producers. But consumers benefit from the competition provided by foreign imports. Imported goods
often drive down the price and improve the quality of goods in the market.
3.1
(International Trade and Development) From the perspective of citizens in a developing country,
what are some of the benefits and drawbacks of international trade?
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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International trade means that people in developing countries have access to products that might not
otherwise be available. Imports also offer more competition for local goods, keeping local producers
on their toes. So consumers can buy a wider range of products and at a lower price. But some of
these same consumers also supply resources to produce goods that face competition from imports,
so this could threaten their jobs. For example, a local farmer could be priced out of business by
lower-priced imports grown on larger farms with better technology.
4.1
(Foreign Aid and Economic Development) Foreign aid, if it is to be successful in enhancing
economic development, must lead to a more productive economy. Describe some of the problems in
achieving such an objective through foreign aid.
Foreign aid does not always translate into the human and physical capital developing countries
need to become more productive. Some foreign aid merely extends the life of a corrupt government,
or, worse yet, provides a pool of funds to be siphoned off into Swiss bank accounts by corrupt
leaders and their cronies. Some foreign aid simply increases consumption in poor countries and
does little to increase a country’s ability to become self-sufficient.
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Case Studies
These cases are available to students online at www.cengagebrain.com.
Night Lights and Income
GDP and economic growth are measured poorly for many developing economies. J. Vernon Henderson
and two colleagues from Brown University have proposed a different measure of economic activity that
does not rely on any of the usual statistics, such as employment, income, or output. Their approach uses
photos taken at night from outer space to measure the density of light on the ground. Consumption of most
goods and services in the evening requires light. As personal income rises, so does consumption and night
lights. Using U.S. Air Force weather satellite photos, the researchers observe changes in a region’s light
density over a 10-year period. They use this change in light to supplement existing income growth
measures.
For example, the trio examine the differential effects of the economic transition on income and light in
former Soviet republics versus neighboring Eastern Europe. In particular, they compare the former Soviet
republics of Moldova and Ukraine, where per capita income fell in the wake of the USSR’s breakup, with
neighboring Hungary, Poland, and Romania, countries that experienced a much smoother and more successful transition from central planning. The two photos below show night lights in Hungary, Poland, and
Romania in the left portion of each photo and Moldova and Ukraine in the right portion of each photo.
The photo on the left was taken in 1992 and the one on the right in 2002. The photos show that the more
brightly lit areas in 2002 are in the Eastern European countries (the left half portion of the right-hand photo), where light intensity increases from 1992 to 2002. Also noticeable is the dimming of lights for their
neighbors on the right of the photo, who were formerly part of the Soviet Union. In Moldova and in
Ukraine, income per capita fell by an average of 33 percent, and light intensity dropped by an average of
57 percent. In Hungary, Poland, and Romania, where income per capita rose by an average of 40 percent,
light intensity rose an average of 64 percent.
When the researchers use their approach on countries with especially low-quality national income data, the night-light measure sometimes differs from the standard measure of income. For example, in the
Congo, night lights suggest a 27 percent rise in GDP from 1992 to 2002, but official estimates of income
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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indicate a 23 percent drop over the same time period. Thus, the Congo seems to be growing faster than
official estimates suggest. On the other hand, although official data for Myanmar are limited, what’s available suggests an income growth of 128 percent during the ten years, but the night-light data imply growth
of only 40 percent.
The night-light approach is most valuable where the quality of other data are poor, such as in many
African economies, or when data are simply not available, such as for Somalia, Liberia, and North Korea.
The three economists don’t expect their night-light measure to replace official estimates of income and
growth, but, rather, to complement these data, especially where statistics are of poor quality or nonexistent.
Sources: J. Vernon Henderson, Adam Storeygard, and David Weil, “Measuring Economic Growth from
Outer Space,” NBER Working Paper, (July 2009). NOAA, National Geophysical Data Center, Data 1992
F-10 and 2002 F-15, http://www.ngdc.noaa.gov/dmsp/downloadV4composites.html#AXP
The Poorest Billion
Not long ago, the world was one-sixth rich and five-sixths poor. Now, thanks to impressive growth in
places like China, the world is more like one-sixth rich, two-thirds not rich but improving, and one-sixth
poor and going nowhere. Most developing economies are experiencing a rising standard of living. But that
still leaves about a billion people trapped in economies that are not only extremely poor, but stagnant or
getting worse. All told, about 45 countries fit into this poorest-billion category, including 30 countries in
sub-Saharan Africa plus the likes of Cambodia, Haiti, Laos, Myanmar, North Korea, and Yemen.
Economist Paul Collier, of Oxford University in England, has examined what went wrong with these
“trapped countries.” Based on decades of research, he identifies some poverty traps. About 750 million
people of the bottom billion have recently lived through, or are still in the midst of, a civil war. Such wars
can drag on for years with economically disastrous consequences. For example, the ethnic conflict in Burundi between the Hutus and the Tutsis has lasted three decades, which helps explain why that country is
among the poorest in the world. And war in the Congo over the last dozen years has killed more than five
million people. Unfortunately, the poorer a country becomes, the more likely it is to succumb to civil war.
And once a country goes through one civil war, more are likely. Ethnic conflict, or civil war, is Collier’s
first poverty trap.
But why, aside from poverty itself, are so many sub-Saharan countries mired in civil war? He finds that
three factors heighten the risk of such conflicts: (1) a relatively high proportion of young, uneducated men
with few job prospects (who, thus, have a low opportunity cost); (2) an imbalance between ethnic groups,
with one tending to outnumber the rest; and (3) a supply of natural resources like diamonds or oil, which
both creates an incentive to rebel and helps finance that rebellion. The presence of mineral wealth in an
otherwise poor country can also undermine democracy itself. Government revenue from mineral sales reduces taxes, which dampens public debate about how taxes should be spent. For example, because of oil
revenue, the Nigerian government relies less on taxes, so there is less pressure for government accountability, and hence fewer checks and balances on a corrupt government. Thus, misuse of natural resource
wealth is Collier’s second poverty trap. About 300 million of the poorest billion live in countries that have
fallen into this trap.
This leads us to the third poverty trap: a dysfunctional or corrupt government. Government officials
who pursue self- glorification and self-enrichment do serious harm to the economy. Much of the public
budget disappears through wasteful programs rife with graft and payoffs. For example, a recent survey that
tracked government funds for rural health clinics in Chad found that less than 1 percent of the money
reached the clinics. About 750 million of the poorest billion live in countries that pursue disastrous economic policies or where government corruption harms the economy.
Can these poorest billion be helped? It will take more than band concerts. Collier doubts that unconditional foreign aid makes much of a difference. He points to the ill effects of oil as an unconditional source
of government revenue. International trade may help, but because these countries have difficulty compet© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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ing with the likes of China or Vietnam, they may need special trade advantages. Another way the rest of
the world could help is by requiring Western banks to report deposits by corrupt officials. The rest of the
world could also assist these poor countries develop laws and regulations to ensure the transparent management of natural resources, to help detect fiscal fraud, and to promote a free press. But even with all
that, what these countries need most, Collier argues, is about 10 years of domestic peace—backed by an
outside force if necessary, such as the UN. All that is a tall order, but the stakes are high for the billion
people trapped and going nowhere in these poor nations.
Sources: Paul Collier, The Bottom Billion: Why the Poorest Countries Are Failing and What Can Be Done
About It, (Oxford University Press, 2007); and Paul Collier, The Plundered Planet, (Oxford University
Press, 2010).
Experiential Exercises
1.
Many developing countries seem more concerned about global warming issues and the potential
effects on economies than do developed countries. Students might visit sites such as
http://www.antara.co.id/en (in Indonesia), http://news.mongabay.com, http://www.americansworld.org/digest/global_issues/global_warming/gw3.cfm, or http://www.globalissues.org/
EnvIssues/GlobalWarming.asp for articles and statistics about various global warming issues that
could affect the development of fledgling economies. Why are attitudes about global warming
different in economically developed countries than in transitional and developing countries?
2. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues
in Context. In the Basic Search box at the top of the page, enter the phrase "import substitution." On
the Results page, go to the News Section. Click on the link for the September 17, 2010, article "Uzbekistan Aims at Import Substitution." What is limiting the success of Uzbekistan's import substitution
strategy?
The article highlights an unfavorable business climate and worn-out equipment. Examples of the former include "the arbitrariness of officials and regulatory bodies, legal insecurity, difficult access to
loans and high taxes."
3. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues
in Context. Go to the menu at the top of the page and click on the tab for Browse Issues and Topics.
Choose Business and Economy. Click on the link for the World Bank. Find one article supporting the
work of the World Bank and one article against. Compare and contrast the arguments in the articles.
Student answers will vary, but should explore some of the benefits and drawbacks for foreign aid
discussed in the chapter.
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Additional Questions and Problems
(From student Web site at www.cengagebrain.com)
1. (Developing Countries) Why is agricultural productivity in developing countries usually so low?
Farmers there work with less capital, more primitive technology, and work on smaller plots so they
are less able to benefit from the economies of larger scale production.
2. (Worlds Apart) Compare developing and industrial market economies on the basis of each of the
following general economic characteristics and relate the differences to the process of development.
a. Diversity of the industrial base
b. Child mortality rates
c. Educational level of the labor force
a. Developing countries are more agricultural and export crops and raw materials. Industrial
market economies have a broader base of agriculture, manufacturing, and services.
b. Child mortality rates are much higher in developing economies than in industrial market
economies.
c. Education levels are much lower in developing economies, and child labor is more common.
3. (Productivity and Development) Among the problems that hinder growth in developing economies
are poor infrastructure, lack of financial institutions and a sound money supply, a low saving rate,
poor capital base, and lack of foreign exchange. Explain how these problems are interconnected.
If people have little confidence that the local currency will retain its value over time, they have less
incentive to save money. After all, why save, if your savings will be eroded by inflation? What’s
more, after some households spend for their basic needs, they have nothing left to save. And people
have less confidence in the banking system and withdraw their savings at the slightest sign of
trouble. If banks cannot rely on a certain level of savings, they have more difficulty making loans to
new businesses. This reduces the amount of physical capital in the economy. All this keeps
production low and means that developing countries produce little of what other countries want to
buy. Thus, developing countries fail to get the foreign exchange needed to finance the importation of
the capital goods needed to increase productivity.
4.
(Rules of the Game) How does privatization contribute to productivity?
Student answers may vary somewhat, but should recognize the efficiencies of market coordination,
the incentives derived from private ownership of resources, and the improved allocation of financial
capital when profit and not politics is the goal.
5. (Classifications of Economies) What are the arguments for using real per capita GNI to compare
living standards between countries? What weakness does this measure have?
What a country produces per capita offers a fair indication of the income available for consumption,
and consumption per person is a good measure of the standard of living. One problem with this
measure is that incomes may be unevenly distributed, so that most of the income is earned by a
fraction of the population. A per capita measure looks at the amount produced on average per
person, but that income may be much more unevenly distributed in some countries than in others.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 20
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6. (Foreign Aid and Economic Development) It is widely recognized that foreign aid that promotes
productivity in developing economies is superior to merely shipping products like food to these
countries. Yet the latter is the approach frequently taken. Why do you think this is the case?
In the countries providing foreign aid, producer groups, especially farmers, lobby public officials to
offer their products as foreign aid. For example, faced with a glut of wheat and cotton in U.S.
markets, farmers convince public officials to supply these products as part of a foreign aid package.
ANSWERS TO ONLINE CASE STUDIES
1.
(CaseStudy: Night Lights and Income) Is the relationship between night lights and income an example of the association-is-causation fallacy? Why or why not?
As defined in Chapter 1, the association-is-causation fallacy is the incorrect idea that, if two variables are associated in time, one must necessarily cause the other. The relationship between night
lights and income is not an example of this fallacy. As the Case Study states, higher income leads to
higher consumption, both during the day and during the night. Nighttime consumption leads to the
use of lights. So there is causation that runs from income to consumption to night lights.
2. (CaseStudy: The Poorest Billion) What three poverty traps help explain the plight of nations
comprising the poorest billion people?
Poverty traps among the world’s poorest billion include (1) civil wars, (2) allowing resource wealth
to cause internal conflicts and undermine democracy, and (3) tolerating a dysfunctional and corrupt
government.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.