Why is Economic Development so Difficult? [2 – June ]

Review n Many conceptions of human development –Roosevelt: four freedoms –Sen: sustenance, self-esteem, freedom –Stiglitz: transformation of society –HDI: life expectancy, literacy, enrollment, GDP per capita (PPP$) n Economic Growth correlates with human development, and in particular n Growth helps the poor – 1% in overall GDP per capita = 1% in GDP per capita for poorest 20%

Great Structural Diversity among Developing Economies n Size and income level n Historical background n Physical and human resources n Ethnic and religious composition n Relative importance of public and private sectors n Industrial structure n External dependence n Political structure, power, and interest groups

But, they face Common Challenges: n Extremely Low per capita GDP n Low or negative GDP growth over time n Growing disparity between richest and poorest countries

Sructural Challenges: n High dependence on agriculture and primary product exports n Rapid rural-urban migration n Low levels of productivity n High rates of population growth and dependency burdens

Basic Structure of Economies: Africa vs. Asia vs. U.S.:

Deeper Economic Challenges n Macroeconomic: –High inflation –Black markets for foreign exchange –Trade barriers imposed by rich countries –External debt (?)

Deeper Economic Challenges Microeconomic: imperfect or missing markets –Markets for borrowing, saving, and investing (credit and financial markets) –Markets for spreading risk (insurance markets)

Deeper Economic Challenges: Imperfect Information n Markets work well when buyers and sellers have good information n Markets fail or don’t exist when buyers or sellers (or both) have poor information n Poor information is not the same as “little information” (recall our auction) n Markets can work poorly when buyers have information but sellers do not, or vice versa – asymmetric information

Imperfect Information: Example n Lenders do not know if farmer is good credit risk…… n Farmers have no collateral (the developed countries solution to this problem) n Hence, farmer cannot get loan to buy land, n Hence, farmer must somehow rent the land….perhaps by sharecropping n Which does not give farmer full marginal benefit of his labor – “inefficient”

Without Credit and Insurance: n People live “on the economic edge” n A small shock can mean ruin: –Illness  can’t work, no income –[no unemployment, no insurance] –Sell assets for medicine, food –[What assets???] –Future productivity drops

Social Challenges: Missing Institutions n A market economy needs: –Security, peace –Justice system to enforce contracts –Financial system: To collect funds from savers Allocate credit to borrowers Stable currency –Transaction information (what am I buying?) –Effective, fair, government

What about Science and Technology? n We will see that technological progress is the only real source of long-run growth n Technology is already here….. n Why can’t LDCs take advantage of past (and current) discoveries?

Sachs’ “Quadruple Bind” n 1) Innovation responds to demand. Demand comes from rich countries n 2) Innovation requires critical mass of science. Poor countries have no critical mass n 3) Existing knowledge applies to temperate zones n 4) climate change limits world growth (shakier argument)

Looking Ahead: The Quest for Growth (in per capita GDP) n Does Aid for Investment for Machines cause growth? n Does Education for Skills cause growth? n (Does controlling population cause growth?) n Does reducing debt cause growth? n What is a poverty trap? n How can people escape from poverty traps? n How can policy and institutions be improved to help people escape from poverty traps?