1. Chapter 5

2.  Are “initial conditions” important in determining final outcomes for countries?  Does it matter where a country starts its development process from?  Is it possible that two countries with similar potential for development end up at two different equilibria?  These questions lead to a study of the relationship between history and expectations in determining the process of economic development.

3.  Complementarities  Complementarities:  coordination failures  linkages  Increasing returns and development social norms status quo  The role of social norms and status quo

4.  Complementarities common  Complementarities : type of externalities that create incentives (or disincentives) for economic agents to adopt a common course of action.  Example: QWERTY vs. Dvorak keyboards for typewriters and computers  It makes sense to adopt a technology because everyone else is using or adopting it. This lowers the cost of adoption and learning for a new user (returns to an individual depends on what everybody else is doing)  Even if a new alternative technology appears on the market that is more cost-effective, it may never get adopted because no one is expected to deviate from the older (and possibly more inefficient) technology.

6.  Both history (the existing technology being a leader in the market) and expectations (no one is expected to adopt the new technology) interact to prevent a new equilibrium from being attained (even though it is perfectly feasible).  Therefore, the economy can be stuck in a “bad” or inefficient equilibrium, even though a “good” or more efficient equilibrium exists. coordination failure  This phenomenon is called a coordination failure:  Individuals fail to coordinate to reach the good equilibrium, either due to history or expectations about the future, or both.

7.  What happens when the cost of an action increases with the number of users? negative  No complementarities, but negative externalities  Does history or expectations matter?  Suppose there are two ways to travel between two cities. Call these Routes A and B.  Cost to a commuter depends on congestion on the route she is using: the more the traffic, higher is her adoption cost for a route

8. BA

9.  Complementarities can cause an economy to be stuck in a “low-level equilibrium trap.”  A “better” equilibrium cannot be reached because individuals cannot coordinate their actions  Rosenstein-Rodan (1943): economic underdevelopment is due to a massive coordination failure  Critical investments do not occur because complementary investments are not made  One feeds on the other perpetually  But if individuals expect others to make complementary investments, then coordination can be achieved; otherwise, no one will want to make investments  Multiple equilibria (“good” and “bad”), depending on underlying expectations about the actions of others  This can explain why regions that have been historically poor remain poor, while others that have been historically rich become richer, even though there are no intrinsic differences between them!

10.  Linkages  Linkages can be crucial in overcoming the coordination problem: one action or activity might create appropriate conditions for another activity. forward linkage  A forward linkage lowers the cost of production for another activity backward linkage  A backward linkage raises the demand for another activity or good.

12. big push  A historically “depressed” economy can be given a big push by the government:  A simultaneous creation of coordinated investments in many different sectors  Problems with the “big push” theory:  The government needs to know the correct mix of investments (why?)  Informational requirements are huge and impractical

13. selectively  Instead of all-round investments, government can create incentives selectively for certain “leading” sectors, and let the market correct the coordination failure  Sectors that are “favored” or “promoted” will generate linkages and create incentives for further investments  Growth will be “unbalanced” in the short run, but the leading sectors will eventually pull the economy out of its low-level equilibrium  Examples of leading sectors: heavy industry, exports, tourism, and agriculture

14.  What we have learnt so far:  History  History often determines equilibrium, and makes it difficult for economic agents to coordinate to “escape” a low level “trap” expectations  If somehow expectations of economic agents could be changed, economy could escape the trap to a better equilibrium  Critical question  Critical question: what prevents expectations from changing?

16. fixed costs  In the presence of fixed costs, a firm’s average cost of production decreases as its production volume increases.  This typically happens in markets that are imperfectly competitive.  The ability to exploit increasing returns depends on:  Size of the market  Size of the market in turn may depend on the firm’s ability to exploit increasing returns  The inability to exploit increasing returns can lead to “development traps”

18.  Social Norms:  Individual actions are often tempered by what society thinks is “acceptable”  Social norms are sustained over time by the immense desire for human beings to “conform”  As development proceeds, certain social norms can be “sluggish” to change  Need for conformity can create disincentives for innovation

19.  Status Quo:  The implementation of certain policies can create winners and losers, even though it raises total welfare of a society.  Problems can arise due to an inability to value the gains or losses and identification of winners and losers  If losers cannot be compensated by winners, then implementing such policies can be difficult (they may face political opposition) which, in turn, can slow down the pace of development.