Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 11 Development Policymaking and the Roles of Market, State, and Civil Society

Copyright © 2009 Pearson Addison-Wesley. All rights reserved System of Economic Management Mixed economy Private sector: profit maximizing business firms Public sector: employment maximizing government agencies Economic systems Capitalism: large private sector, but small public sector Socialism: large public sector, but small private sector

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Economic Role of the State Protect private property and legal rights Produce public goods Improve market competition Improve income distribution Preserve the human environment Manage the economy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Development Planning Economic plan: managing economic activity Specific set of quantitative targets Given time horizon (three or five years) Stated strategies for achieving the targets Comprehensive (the entire economy) or partial (a specific sector or industry) coverage

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Component of Development Plan Government uses domestic saving and foreign exchange to construct economic infrastructure Government implements economic policy (taxation, industrialization, foreign exchange control, trade restriction)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Rationale for Planning Reduce market failure: Income distribution Monopoly power Externalities of production and consumption Insufficient information

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Rationale for Planning Resource mobilization and allocation Psychological effect on achieving development goals (e.g., reducing poverty) Foreign aid: a requirement to obtain loans and grants

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Planning Characteristics Governmental goals and objectives Strategies for achieving goals and objectives Government agency for planning implementation Planning coverage: comprehensive or partial Planning horizon: medium or long-term Planning methodology (macroeconomic model)

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Planning Methodology Aggregate growth model (Harrod-Domar) Investment demand = National saving Foreign aid and direct foreign investment to fill-in the saving gap

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Planning Methodology Input-Output model Outputs of industries serve as inputs of other industries Optimal input mix to produce maximum output to satisfy the final demand

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Project Appraisal Weigh the costs of plans/projects against their benefits over the planning horizon Discount the costs and benefits and compare their present values Find an appropriate “discount factor” above the internal rate of return” “Net” at which present value equal to zero

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Project Appraisal Net present value, or NPV is given by Where B t is the expected benefit at time t C t is the expected cost at time t r is the government’s social rate of discount

Copyright © 2009 Pearson Addison-Wesley. All rights reserved True vs. Actual Market Value True market value in the demand-supply price or scarcity value = shadow price reflecting social costs and benefits Actual market value is the market exchanged price reflecting private costs and benefits or the controlled price

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Reasons for Price Divergence Inflation and currency control Factor price distortions (prices, wages, interest rates, exchange rate) Trade restrictions and import substitution Saving deficiency Social vs. private rate of return

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Planning Consequences Factor price distortion, choice of technology and employment creation Induced R-U migration Demand for educational certification leading to employment problem Economic structure

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Reasons for Failure of Planning Deficiencies in plans and their implementations External and internal disturbances Insufficient and unreliable data Institutional weaknesses Lack of political will Corruption of public servants

Copyright © 2009 Pearson Addison-Wesley. All rights reserved The Planning Mystique In the past, few doubted the importance and usefulness of national economic plans Recently, however, disillusionment has set But, a comprehensive development policy framework can play an important role in accelerating growth and reducing poverty

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Resurgent of Market Orientation Failure of planning IMF and World Bank policy requirements for foreign aid and direct foreign investment Joint ventures of domestic and foreign enterprises

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Requirements for Market Orientation Trust Law and order Security of private property rights Balancing between competition and cooperation Division of responsibility and diffusion of power Social safety net

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Requirements for Market Orientation Social mobility Individualism and materialism Deferring gratification to create private saving Rationality and efficiency Honesty of government Competition of business Availability and freedom of information

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Need for Government Intervention Income redistribution through progressive taxation and transfer payments Excess market imperfection on behalf of domestic and foreign business Substantial negative externalities (pollution and decay) Investment in social and human capital Structural transformation

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Planning & Market Reconciliation Must achieve “effective” cooperation Must reduce market imperfections Must eliminate factor price distortions and price controls Must reduce public ownership of economic enterprises Must reduce corruption and red tape

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Non-Government Organizations Comparative advantages of NGOs in – Innovative design and implementation – Program flexibility – Specialized technical knowledge – Provision of targeted local public goods – Common-property resource management design and implementation – Trust and Credibility – Representation and advocacy

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Corruption and Planning Corruption: Abuse of public trust for private gain Good governance enhances capability to function Effects of corruption fall disproportionately on the poor Good governance is broader than simply an absence of corruption

Copyright © 2009 Pearson Addison-Wesley. All rights reserved Corruption as a Regressive Tax: The Case of Ecuador

Copyright © 2009 Pearson Addison-Wesley. All rights reserved The Association between Rule of Law and Per Capita Income