Presentation on theme: "Economic Development Theories"— Presentation transcript:
1NS4053 Winter Term 2013 Theories of Economic Development Trap Models, Vicious Circles
2Economic Development Theories Broad Classes of TheoriesStage TheoriesRostow – 5 stagesBremer and Kasarda – failed take-off – New Second WorldPorter – modern upgradingSachs – environmental settingsWorld Economic Forum competitiveness stages (empirical section)Trap TheoriesPoverty TrapsMiddle Income TrapVicious CirclesBalanced vs. Unbalanced GrowthBig Push TheoriesSector/Dualism ModelsLewis – classical modelFei-Ranis – two sector
3Trap Models I Trap models cover a variety of situations. One set of problems involves starting growth in situations where gradualism and incremental actions are unlikely to result in permanent increases in income – poverty trapsAnother set of problems occur when growth comes up against constraints that cause it to stall-out -- transition/growth trapsAll countries possess growth enhancing factors and elements that suppress growth.Trap models assume that the growth suppressing forces neutralize growth enhancing factors, so that a quantum shift in policy is needed to start growthTrap models often involve some sort of feed-back effect enforcing the trap – vicious circleEarly models largely poverty traps.As growth has stalled in some countries, newer transition gap models developed
4Trap Models IIEarly poverty trap models assumed rapid rates of population growth, peaking out at some biological maximum.If the rate of growth of population exceeds that of the economy – forces per-capita income down to low level – growth may be slow because of potential savings used to raise children rather than flow into investmentFor increases in per-capita income to be sustained to reach higher standards of living, need to have rapid growth above that of the population – once occurs savings flows into investment
5Trap Models IIIMore recent poverty trap models focus on situations whereby an individual, a group of households, a country or geographic region occupies a stable equilibrium at a low level of wealth and outputHave provided one rational for foreign aid programs and were the impious for the UN’s Millennium projectMany of the newer models follow Sachs’ research in AfricaSubstantial level of foreign aid over an adeqate time frame raise capital stock and contribute to growthRaises households out of povertyGrowth cumulative as households saved and pu blic investments were facilitated by household taxationResearch has shown that aid has not generated the big growth effects anticipated by the existence of poverty traps.
6Trap Models IV Easterly, formerly with the World bank found: Growth is lower in aid-intensive countries than in developing countries that get little aidAid has risen over time as a percent of income in Africa, but Africa’s growth rate has fallen over timeThe difference in growth rates between the poorest one fifth of countries in 1950 and the others ranked by per-caita income over time to 2001 was not statistically significantCountries that filed to grow within the poorest group – Chad, DRC – were offset by those that did grow – Botswana, Lesotho, China, IndiaEasterly also finds no evidence for the poverty trap based on the assumptions of:A lower growth rate for the poorest countries andA per-capita growth rate of zero in the poorest countries
7Trap Models V Easterly statistical findings on poverty trap No statistical difference between the growth rate of the poorest 20%, 1.9% and others over periodSimilar for and periodsData from 1985 suggest poorest countries have fared worse, but comes at a time when poorest countries were getting more foreign aid as % of their incomes.
8Trap Models VIIn sum, evidence for poverty traps based on an income criteria is easily refutedStill no denying that some countries remain poor while others become richerThe scenario of a widening income disparity over time between poorer and richer countries is another form of poverty trap – a divergence trapWhat maintains the inequality trap?Insufficient savings as suggested by the poverty trap orAn institutional poverty trapCurrent thinking:countries with sound institutional frameworks – property rights, sound legal system experience higher rates of growthalso that higher rates of growth is good for poverty reduction
9Trap Models VII Importance of institutions: The effectiveness of public policies designed to encourage capital accumulation, knowledge and technological creation depend on underlying institutionsRight institutions can provide incentives for economic growthClearly a reward structure that provides incentives for individuals and corporations to undertake investments in new technology and human capital that are necessary for growthThe political system – authoritarian or participatory – creates different types of reward structure with the latter found to provide a growth-promoting cluster of institutionsGovernments that do not provide a reward structure – often corrupt and oversee a system of weak institutions.Easterly attributes the unsatisfactory growth record of the poorest countries to having “more to do with awful government than with a poverty trap.”
10The Iraqi Economy I: Overview History and Key Issues Army Human Terrain TeamFt. Leavenworth, Kansas November 13, 2009Dr. Robert E. Looney
11Iraqi Case StudyAccording to the World Bank, successful economic development is more likely in countries that perform well in these 6 areas of governance:Voice and AccountabilityPolitical StabilityGovernment EffectivenessRegulatory QualityRule of LawControl of Corruption
12Iraq: Voice and Accountability Updated with 2009 WB governance data base: includes Sudan, Lebanon, Turkey
13Political Stability -- Absence of Violence/Terrorism
18Corruption and the Economy Of the governance measures, corruption may have the worst economic consequences because it:Reduces economic growthWorsens distribution of incomeIncreases government inefficiencyWorsens the international balance – foreign investmentReduces the confidence of the Iraqi people in their own governmentReduces the availability of foreign loans and grants
19Corruption and the Insurgency The insurgency is good for corruptionIt justifies bypassing proceduresIt increases the necessity for getting things done, regardless of the costIt provides an excuse for corruption-related lossesCorruption is good for the insurgencyTerrorist groups finance their operations, in part, with proceeds from corruptionCriminal groups that handle smuggled or stolen goods provide routes and safe houses for terrorists, IED makings, etc.Corruption undermines confidence in the GOI
20The Most Corrupt Ministry Ministry of Trade (MoT) is the most corrupt ministryIt is responsible for the Public Distribution SystemIt controls a number of State EnterprisesThe same officials write regulations, execute them and “investigate” problemsAs a result, there are few investigations, no convictions, and almost zero transparencyOne analyst referred to MoI as a RICO organization: A legitimate organization that has been thoroughly infiltrated by a criminal group that now work through the legitimate organization to commit extortion, bribery, kidnapping and murder for hire.MoI and MoT – both dominated by Shi’aHonest ministries? MoF maybe
21Consequences of Poor Governance I The government is unable to manage increased earnings from oil exports in order to develop the economyWhile Iraq’s total expenditures increased from 2005 through 2007, Iraq spent a declining share of its budget allocations – 73 to 65 percent from 2005 to 2007.In each year, Iraq spent a greater percentage of its operating budget, including salaries, than its investment budget.For example in 2007, the Iraqi government spent 80 percent of its $28.9 billion operating budget and 28 percent of its $12.2 billion investment budget.The central ministries responsible for providing essential services to the Iraqi people spent a smaller share of their budgets than the Iraqi government as a whole. Further, their investment ratios declined from 14 percent in 2005 to 11 percent in 2007.
25Consequences of Poor Governance II Affect on Policymaking:Economic policymaking will continue to be constrained by the weakness of central government control.Consequently the government’s primary aim wil be to improve project implementation in part by encouraging greater local participation and cutting bureaucratic constraints.Although progress will remain slow and piecemeal, hindered by vested interests and rampant corruption, better security should at least allow progress on upgrading basic services.Despite failure to pass a federal hydrocarbons law, several development contracts with foreign oil firms are likely to be signed – critical to compensate for the fall in oil prices.
26Iraq: Masures of Progress and Unity Anthony Cordesman identifies key tests of progress and unity:Quality, integrity and equity of government services: education, medical services, water and electricitySharing the state budget and oil wealth by region, sect, ethnicityVolume of oil revenues, development of petroleum sector.Agricultural reform.Reform of state industries sector and employmentEmployment and income distribution; who gets government jobs and key appointments.Limits to excessive corruption and power brokers.Anthony Cordesman, Shape, Clear, Hold and Build: The Uncewrtain Lessons of the Afghan & Iraq wars: Part III Iraq, Sept 21, 2009 p. 62
27Iraq: Progress in State Stability Source: Fund For Peace, Failed State Index, 2009
28Summary: Measures of Progress New York Times State of Iraq, June 22, 2008
29Summary: Reconstruction to Date While there has been some progress since 2003, the picture is still far from encouragingUnemployment has stabilized at 18% with another 10% underemployed.The supply of electricity, fuel and water is unreliable and unstableMany Iraqi households have lower incomes now than in 1980, and there has been massive capital flight and brain drainThere has been a great deterioration in social capital, characterized by a general loss of trust and a corruption rate that is the highest in the Middle EastThere is an extremely high crime rate and the Shadow Economy may make up 40% of GDP and 50% of employment
30Summary: Concerns for the Future Despite improved security and reduced violence the economy faces a number of challenges:Foreign aid is winding down, without effective development and growth of the private sector.With the decline in oil prices and revenues, the budget goal for has dropped from $78-80B to $72B to $68B to 62B to 58B.Macroeconomic data disguise key sectoral problems in services, manufacturing, and agriculture.Despite attempts to diversify economy government spending remains the glue that holds the government and economy together.Some 70% of paid jobs linked to the government whose income is 95% driven by the oil sector.Still have major weaknesses in Ministries, governance and budgetary execution.
31Middle Income Trap IThe middle-income trap refers to situation whereby a middle-income country is failing to transition to a high-income economyRising costsDeclining competitivenessFew countries successfully manage the transition from low to middle to high incomeMany countries in Latin America and Middle East regions have been stuck in this middle income trapStruggling to remain competitive as high volume, low cost producers in the fact of rising wage costsThe hallmarks of success become the binding constraints for these countriesEvidence to support the middle-income trap indicates a leveling off of income per capita and a decline or stagnation in an economy’s competitiveness
32Middle Income Trap IIKorea, Brazil, Philippines and Syria took off in growth from the mid 1970s.Korea continued to growth through the 1980s, achieving almost $8,000 per capita income in 2006The other countries leveled off over the period.
33Middle Income Trap IIIMalaysia, Thailand, Indonesia and Philippines all experienced stagnation in global competitiveness over period to 2009
34Middle Income Trap IVResearch at the World Bank identifies two key ingredients that comprise a number of others:High levels of investment that embody new technologiesInnovation-conducive policiesInvestment levels of 25% of GDP or more are needed to achieve strong growthInvestment rates in Korea and Japan have averaged 31% since their respective takeoffs in 1978 and 1950Transitioning to a high-growth economy requires a move up the value chainInnovation in new products and processes both in adoption and development as well as business operation is criticalA good innovation policy requiresCreating incentives for productive entrepreneurshipProviding adequate skills to the workforceEnsuring good transmission of information and ideas; andMaking sure that financing is available for start-ups, upgrades and commercialization
35Vicious Circle Models: I A variant of the trap models entails vicious circlesTheory indicates that poverty perpetuates itself in mutually reinforcing vicious circles on both the supply and demand sideSupply SideBecause incomes are low, consumption cannot be diverted from capital formationLack of capital results in low productivity which perpetuates low incomeA country is poor because it was previously too poor to save and invest.Demand SideBecause incomes are low market size (for many consumer goods) is too small to encourage investorsLack of investment leads to low productivity and continued low incomeA country is poor because it was previously too poor to provide the market to spur investment
36Vicious Circle Models II Critique – Insufficient SavingsVicious circle seems plausible to those who imagine the entire population is poor and hungry – surprised anyone savesReason to believe developing populations can save substantially more than they do.Highest income groups often live far above subsistence levelsIndia’s richest 10 percent receive about 34 percent of national income – amount per head nine to ten times that of the poorest 10 percentEvidence indicates that consumption levels are determined less by absolute income than by relative income (income in comparison to neighbors and community members)Thus richer income classes could save considerably if they were sufficiently motivated.
37Vicious Circle Models III One reason may not do so is because of the demonstration effect of consumption levels in the West and of elites in their own countriesStill personal savings is usually a small proportion of developing country savingsCorporate saving, government saving, public enterprise profits, social security premiums, and the like may be other sources of savingAlways seems to be plenty of money for waging warCritique: Small MarketsFact is many markets are ample for using modern production methods – sugar mills, textiles etcStudies have found that “economies of experience” are more important for large-scale production than economies of scale from increased market size.As with trap models, modern vicious circle models usually incorporate some type of institutional failure as responsible for stagnation
40Vicious Circles: Iraq Case Study I Many of the economic/social/political forces in Iraq are interrelated. The key to growth is to draw on these compatibilities and create an environment in which each builds on the other. To accomplish this:The economic reform process needs to be deepened and completed.Major improvements in governance are essential.Oil production needs to expand to million b/d.The political environment must become encompassing.There needs to be a more equitable direct sharing of oil revenues.Macroeconomic stability must be maintained with inflation at %.Corruption levels must begin declining.The provinces must gain greater control over their funding.
41Vicious Circles: Iraq Case Study II A number of key components can work together to create virtuous circles of growth and institutional development:Infrastructure programs create critical imbalances that stimulate follow-on private sector investment, thus making decision-making easier and reduce the uncertainty over future costs.Encouraging Iraq’s entrepreneurial talent promotes the dual-track policy of stimulating the formation of new small- and medium- sized enterprises (SMEs), while drawing informal economy firms into the formal economy.This, in turn, leads to maximum job creation and genuine economic progress, thus weakening the pull of the insurgency.Price reforms remove many of the incentives to revert to the shadow economy and, in turn, facilitate anti-corruption campaigns.With reduced insurgency and corruption, private investors respond to the investment opportunities created by the infrastructure program.
42The Future: Virtuous Circle II Maintenance of improved macroeconomic stability facilitates development of market-based financial instruments, allowing the Central Bank of Iraq to gain better control of monetary and credit policy.Banking system reforms in a stable macroeconomic environment lead to increased funding of small and medium sized enterprises – Track II SMEs .Possible direct distribution of oil revenues helps develop domestic markets, thus creating real demand for new and growing enterprises.New firms, workers, and a large portion of the population have a stake in moving the reform process ahead.Expanded reforms reduce corruption and improve the regulatory climate – perhaps slowing or reversing the brain drain.With improved governance comes higher economic growth and the stimulus for further expansion.
44Vicious Circles: Iraq Case Study IV Critical intangibles likely to influence Iraq’s future economy include:The extent to which economic progress can be made without a significant reduction in corruptionThe speed and degree to which trust can be restoredThe ability of the financial system to play a significant role in private sector investmentThe extent to which a growing economy and expanding job creation can undermine the insurgency.The level to which religious influences are likely to mold the country’s economic institutions and whether they will make the movement to a liberal market economy more difficultThe extent to which the Iraqi government can evolve into a development state – a democratic version of the 1970s regime.The effectiveness of CERP, PRT and other programs in creating viable and dynamic economic activity at the local level.
45Contrasting Views“If I am permitted to dream, Iraq will develop into the Japan of the Middle East.”Talib al-Tabatie, Chairman, Iraq Stock Exchange“It seems that many Iraqis do not understand…why a market economy can make the poor people much better off than they ever were when Saddam controlled the oil wealth and doled out perks to the Iraqis like a stern parent rewards small children for being seen and not heard.”Ronald Rotunda – George Mason University Foundation Professor of Law.“We want to go back to the old healthy management of the 1970s.Thamir Ghadhban – Oil Minister, Iraqi Interim Government
46Balanced/Unbalanced Growth I Many contemporary disputes repeat themes from mid-twentieth-century debates, balanced growth versus unbalanced growthSometimes the debate is semantic – what is balance?Rigid formula with all sectors growing at same rate?More flexible that some attention be given to all major sectors?Other issues in the debatesWhat are the relative merits of strategies of gradualism vs. a big push?Is capital or entrepreneurship the major limitation to growth?
47Balanced/Unbalanced Growth II Synchronized application of capital to a wide range of different industriesOne way of escaping from the vicious circle of povertyEarly theories were pessimistic about exports, so usually applied to sectors of the domestic economyBig Push ThesisAdvocates of synchronized application of capital to all major sectors support the big push thesisArgue a strategy of gradualism is domed failureSubstantial effort is essential to overcome the inertia inherent in a stagnant economyAnalogy to a car being stuck in snow – will not move with a gradually increasing push – needs a big pushLed Tony Blair to call for a big, big push forward in Africa
48Balanced/Unbalanced Growth III Early versions based on idea that the factors that contribute to growth like demand and investment in infrastructure do not increase smoothly, but are subject to sizable jumps or indivisibilitiesIndivisibilities result from flaws created in investment market by external economiesCost advantages rendered free by one producer to anotherThese benefits spill over to society as a whole or to some member of it rather than the investor concerned.Example – increased production from investment in the steel industry will benefit other industries as wellGreater output stimulates demand for iron, coal and transportLower costs may make vehicles and aluminum cheaperOther industries may benefit later by hiring laborers who acquired skills in the millsThus the social profitability of this investment exceeds its private profitability –Unless government intervenes, total private investment will be too low
49Balanced/Unbalanced Growth III Indivisibility in Infrastructure:Need whole system – cannot increase incrementallyCan’t build a smaller Aswan Dam or shorter Monterrey-Mexico City telegraph lineIndivisibility in demandArises from the interdependence of investment decisions Prospective investors uncertain whether output from project will find a marketThe workers in an individual project will not buy all of that productHowever investment in a wide variety of industries will create enough purchasing power to buy the available increase in supplyReturn on individual project may be 5% with high uncertainty.Investment on a broad front increased return to 15% with greater certaintyWhat is not true for the individual factory is true for the complementary system of many enterprisesThe new producers are each other’s customers and create additional markets through increased incomesComplementary demand reduces risk of not finding a market increases incentive to invest
50Balanced/Unbalanced Growth IV Possible ExamplesSituations today where world trade is costly – landlocked countries like BoliviaDomestic agriculture or exports may not be sufficient for industrializationSo economies need large domestic marketsHistoric examples:Colombia’s tobacco export boom failed to lead to widespread economic development as incomes went to a few plantation owners who spent on luxury imortsLater from boom in coffee exports, grown on small family enterprises benefited large numbers who demanded domestic manufacturersFor industrialization, incomes from the leading sector must be broadly distributed, providing demand for manufacturing.
51Balanced/Unbalanced Growth V Critique Balanced GrowthAdvocated of balanced growth emphasize a varied package of industrial investment often at the expense of investment in agricultureComparative advantage suggests that a country cannot grow rapidly if it fails to specialize where production is most efficientRecent experience of developing countries suggests they cannot neglect agricultural investment if they are:to feed their populations,supply industrial inputs andearn foreign currency
52Balanced/Unbalanced Growth VI Critique Balanced Growth cont.:Infrastructure is not as indivisible as advocates imply.Roads, rivers, canals, or air traffic can substitute for railroadsRoads my be dirt, graveled or paved and various widthsPower plants can differ greatly in size. Controversy in Iraq over state of art power grids or small generatorsLarge infrasture facilities, although perhaps economical at high leves of development are not essential for growthResources required for carrying out strategy vastIf country had these resources, probably wouldn’t be undevelopedWhere will country obtain the capital, skilled labor and materials needed for such an expansionAlthough new industries may be complementary on the demand side, they are competitors for limited resources on the supply side.
53Balanced/Unbalanced Growth VII Advocates of balanced growth often assume the country starts from scratchIn reality every country starts from a position that reflects previous investment decisionsThus at any time there are highly desirable investment programs that are not balanced in themselves but are well integrated with existing capital imbalancesThe strategy was tarnished by the widespread evidence that developing countries have grown rapidly without any attempt at massive investments in the wide range of industries that advocates considered essential
54Balanced/Unbalanced Growth VIII Hirschman’s strategy of imbalancePart of economic strategy for Iraqi reconstructionIdea that unbalanced investment to complement existing imbalances.He contends that deliberately unbalancing the economy, in line with a predesigned strategy is the best path for growthArgues that the big push thesis may make interesting reading for economists, but most countries don’t have the skills or resources needed to launch such a massive effortThe major shortage in most developing countries is not the supply of savings but the decision to invest by entrepreneurs, the risk takers and decision makersHirschman believes poor countries need a development strategy that spurs investment decisions.He suggests that because resources and abilities are limited, a big push is sensible only in strategically selected industries
55Balanced/Unbalanced Growth IX Hirschman’s Intentional Unbalancing Strategy
56Balanced/Unbalanced Growth X Growth then spreads from one sector to another – similar to Rostow’s concept of leading and following sectorsWhile Unbalanced Growth advocates usually stress the advantages of free markets, they often restrict this to areas outside of investmentExample – Profitability of projects a function of the order in which they are takenTruck factory = return of 10% and steel factory 8%If interest rate is 9% then invest in truck factoryLater as a result of this investment returns on the steel factory increase to 10% so investment then in that industry
57Balanced/Unbalanced Growth XI Or might get situation where:Establishing a steel factory would increase the returns in the truck factory from 10% to 16%Society would be better off investing in the steel sector first and the truck enterprise second rather than making independent decisions based on the marketPlanners need to consider the interdependence of investment projects so that they maximize overall social profitabilityNeed to make the investment that spurs the greatest amount of new investment decisionsInvestments should occur in industries that have the greatest linkages including backward and forward linkages
58Balanced/Unbalanced Growth XII Criticisms of unbalanced growth strategyAs in balanced growth case, many types of infrastructure – may be cheaper to have smaller projects utilized fully than large projects that are underutilized – white elephantsAssumes that there is a lack of decision making in the private sector, but that the government has no trouble in this regardJapan grew through the reverse mechanism – entrepreneurs invested and then pressured the government to alleviate bottlenecksHowever Mexico after the Revolution in the early 1900s found government unbalancing accelerated growthOften not as clear cut where the greatest shortage of decision making lies – public or private sectors.Eventually both strategies lead to balance