© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Prepared by: Fernando & Yvonn Quijano 23 Chapter Economic Growth in Developing and Transitional Economies

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 45 Chapter Outline 23 Economic Growth in Developing and Transitional Economies Life in the Developing Nations: Population and Poverty Economic Development: Sources and Strategies The Sources of Economic Development Strategies for Economic Development Growth versus Development: The Policy Cycle Issues in Economic Development Population Growth Developing-Country Debt Burdens Economies in Transition Political Systems and Economic Systems: Socialism, Capitalism, and Communism Central Planning versus the Market The End of the Soviet Union The Transition to a Market Economy Six Basic Requirements for Successful Transition

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 45 ECONOMIC GROWTH IN DEVELOPING AND TRANSITIONAL ECONOMIES The economic problems facing the developing countries are often quite different from those confronting industrialized nations. The policy options available to governments may also differ. Nonetheless, the tools of economic analysis are as useful in understanding the economies of less developed countries as in understanding the U.S. economy.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 45 LIFE IN THE DEVELOPING NATIONS: POPULATION AND POVERTY TABLE 23.1 Indicators of Economic Development COUNTRY GROUP POPULATION, 2004 GROSS NATIONAL INCOME PER CAPITA, 2004 (DOLLARS) ANNUAL HEALTH EXPENDITURES PER CAPITA 2004 (DOLLARS) INFANT MORTALITY, 2003 (DEATHS BEFORE AGE 5 PER 1,000 BIRTHS) URBAN POPULATION (PERCENTAGE OF TOTAL), 2002 Low-income2.3 billion Lower middle-income2.4 billion1, Upper middle-income million4, High-income1.0 billion32,0402, Source: World Bank, While the developed nations account for only about one-quarter of the world’s population, they are estimated to consume three-quarters of the world’s output. This leaves the developing countries with about three-fourths of the world’s people, but only one-fourth of the world’s income. The simple result is that most of our planet’s population is poor.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 45 In the year 2006, the population of the world and the number of nations were: a.200 billion people and 155 nations. b.6.5 billion and over 200 nations. c.1.2 billion and more than 2,000 nations. d.3.2 billion and more than 300 nations.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 45 In the year 2006, the population of the world and the number of nations were: a.200 billion people and 155 nations. b.6.5 billion and over 200 nations. c.1.2 billion and more than 2,000 nations. d.3.2 billion and more than 300 nations.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Poverty alone cannot explain capital shortages, and poverty is not necessarily self- perpetuating. THE SOURCES OF ECONOMIC DEVELOPMENT Capital Formation vicious-circle-of-poverty hypothesis Suggests that poverty is self-perpetuating because poor nations are unable to save and invest enough to accumulate the capital stock that would help them grow. capital flight The tendency for both human capital and financial capital to leave developing countries in search of higher rates of return elsewhere.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 45 The vicious cycle of poverty is an explanation of poverty that emphasizes: a.Income distribution and wealth accumulation. b.Hunger, illiteracy, and malnutrition. c.Consumption, saving, investment, and capital accumulation. d.Agriculture versus industry and imports versus exports.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 45 The vicious cycle of poverty is an explanation of poverty that emphasizes: a.Income distribution and wealth accumulation. b.Hunger, illiteracy, and malnutrition. c.Consumption, saving, investment, and capital accumulation. d.Agriculture versus industry and imports versus exports.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Development cannot proceed without human resources capable of initiating and managing economic activity. Human Resources and Entrepreneurial Ability brain drain The tendency for talented people from developing countries to become educated in a developed country and remain there after graduation.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES The governments of developing countries can do important and useful things to encourage development, but many of their efforts must be concentrated in areas that the private sector would never touch. If government action in these realms is not forthcoming, economic development may be curtailed by a lack of social overhead capital. Social Overhead Capital social overhead capital Basic infrastructure projects such as roads, power generation, and irrigation systems.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 45 Which of the following statements is correct? a.Poverty alone cannot explain capital shortages, and poverty is not necessarily self perpetuating. b.Development cannot proceed without human resources capable of initiating and managing economic activity. c.The governments of developing countries can do important and useful things to encourage development, especially in areas that the private sector would never touch. d.All of the above statements are correct.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 45 Which of the following statements is correct? a.Poverty alone cannot explain capital shortages, and poverty is not necessarily self perpetuating. b.Development cannot proceed without human resources capable of initiating and managing economic activity. c.The governments of developing countries can do important and useful things to encourage development, especially in areas that the private sector would never touch. d.All of the above statements are correct.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES STRATEGIES FOR ECONOMIC DEVELOPMENT Agriculture or Industry? TABLE 23.2 The Structure of Production in Selected Developed and Developing Economies 2003 COUNTRY PER-CAPITA GROSS NATIONAL INCOME (GNI) PERCENTAGE OF GROSS DOMESTIC PRODUCT AGRICULTUREINDUSTRYSERVICES Tanzania $ Bangladesh China1, Colombia2, Thailand2, Brazil3, Korea (Rep.)13, United States41,4002 Japan37, Source: World Bank,

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Exports or Import Substitution? import substitution An industrial trade strategy that favors developing local industries that can manufacture goods to replace imports. export promotion A trade policy designed to encourage exports.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 45 When imports of manufactured goods become relatively expensive in the domestic market, while exports become relatively inexpensive world markets, a country would naturally tend to choose: a.Import substitution over export promotion. b.Export promotion over import substitution. c.Both import substitution and export promotion. d. Neither import substitution nor export promotion.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 45 When imports of manufactured goods become relatively expensive in the domestic market, while exports become relatively inexpensive world markets, a country would naturally tend to choose: a.Import substitution over export promotion. b.Export promotion over import substitution. c.Both import substitution and export promotion. d. Neither import substitution nor export promotion.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES Central Planning or the Market? International Monetary Fund (IMF) An international agency whose primary goals are to stabilize international exchange rates and to lend money to countries that have problems financing their international transactions. World Bank An international agency that lends money to individual countries for projects that promote economic development.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 45 ECONOMIC DEVELOPMENT: SOURCES AND STRATEGIES structural adjustment A series of programs in developing nations designed to (1) reduce the size of their public sectors through privatization and/or expenditure reductions, (2) decrease their budget deficits, (3) control inflation, and (4) encourage private saving and investment through tax reform. GROWTH VERSUS DEVELOPMENT: THE POLICY CYCLE

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 45 ISSUES IN ECONOMIC DEVELOPMENT Rapid population growth is characteristic of many developing countries. Large families can be economically rational for parents who need support in their old age, or because children offer an important source of labor. However, having many children does not mean a net benefit to society as a whole. Rapid population growth can put a strain on already overburdened public services such as education and health. POPULATION GROWTH The Consequences of Rapid Population Growth

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 45 ISSUES IN ECONOMIC DEVELOPMENT FIGURE 23.1 The Growth of World Population, Projected to 2020 A.D.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 45 Thomas Malthus, England’s first professor of political economy, expressed his fears about: a.Excessive industrialization leading to worker exploitation. b.Geometric growth in population but diminishing marginal productivity of the land. c.The limitations that population growth imposes on saving and investment. d.The inability of societies to improve human capital through nutrition and formal education when population grows too rapidly.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 23 of 45 Thomas Malthus, England’s first professor of political economy, expressed his fears about: a.Excessive industrialization leading to worker exploitation. b.Geometric growth in population but diminishing marginal productivity of the land. c.The limitations that population growth imposes on saving and investment. d.The inability of societies to improve human capital through nutrition and formal education when population grows too rapidly.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 24 of 45 ISSUES IN ECONOMIC DEVELOPMENT Causes of Rapid Population Growth fertility rate The birth rate. Equal to (the number of births per year divided by the population) x 100. mortality rate The death rate. Equal to (the number of deaths per year divided by the population) x 100. natural rate of population increase The difference between the birth rate and the death rate. It does not take migration into account. Any nation that wants to slow its rate of population growth will probably find it necessary to have in place economic incentives for fewer children as well as family planning programs.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 45 The difference between the birth rate and the death rate is called: a.The fertility rate. b.The mortality rate. c.The natural rate of population increase. d.The labor force participation rate. e.The stabilization rate.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 45 The difference between the birth rate and the death rate is called: a.The fertility rate. b.The mortality rate. c.The natural rate of population increase. d.The labor force participation rate. e.The stabilization rate.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 45 ISSUES IN ECONOMIC DEVELOPMENT debt rescheduling An agreement between banks and borrowers through which a new schedule of repayments of the debt is negotiated; often some of the debt is written off and the repayment period is extended. stabilization program An agreement between a borrower country and the International Monetary Fund in which the country agrees to revamp its economic policies to provide incentives for higher export earnings and lower imports. DEVELOPING-COUNTRY DEBT BURDENS

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 28 of 45 ECONOMIES IN TRANSITION For 40 years, between the end of World War II and the mid-1980s, a powerful rivalry existed between the Soviet Union and the United States. We reflect on historical political rivalries in an economics text for two reasons. First, the 40-year struggle between the United States and the Soviet Union was fundamentally a struggle between two economic systems: market-based capitalism (the U.S. system) and centrally planned socialism (the Soviet system). Second, the Cold War ended so abruptly in the late 1980s because the Soviet and Eastern European economies virtually collapsed during that period.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 29 of 45 ECONOMIES IN TRANSITION socialist economy An economy in which most capital is owned by the government instead of private citizens. Also called social ownership. POLITICAL SYSTEMS AND ECONOMIC SYSTEMS: SOCIALISM, CAPITALISM, AND COMMUNISM capitalist economy An economy in which most capital is privately owned. communism An economic system in which the people control the means of production (capital and land) directly, without the intervention of a government or state. Comparing economies today, the real distinction is between centrally planned socialism and capitalism, not between capitalism and communism.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 30 of 45 Which of the following systems is characterized by social ownership of capital? a.A capitalist economy. b.A socialist economy. c.Communism. d.A market-socialist economy.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 31 of 45 Which of the following systems is characterized by social ownership of capital? a.A capitalist economy. b.A socialist economy. c.Communism. d.A market-socialist economy.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 32 of 45 ECONOMIES IN TRANSITION market–socialist economy An economy that combines government ownership with market allocation. CENTRAL PLANNING VERSUS THE MARKET Just as there are no pure capitalist and no pure socialist economies, there are no pure market economies and no pure planned economies. Generally, socialist economies favor central planning over market allocation, while capitalist economies rely to a much greater extent on the market. Nonetheless, some variety exists.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 33 of 45 When comparing economies today, the real distinction is between: a.Centrally planned communism and market socialism. b.Centrally planned socialism and capitalism. c.Capitalism and communism. d.Transitional economies and purely communist economies.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 34 of 45 When comparing economies today, the real distinction is between: a.Centrally planned communism and market socialism. b.Centrally planned socialism and capitalism. c.Capitalism and communism. d.Transitional economies and purely communist economies.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 35 of 45 THE END OF THE SOVIET UNION The Soviet Union grew rapidly through the mid- 1970s. During the late 1950s, the Soviet Union’s economy was growing much faster than that of the United States. The key to early Soviet success was rapid planned capital accumulation. In the late 1970s, things began to deteriorate. Dramatic reforms were finally introduced by Mikhail Gorbachev after his rise to power in Nonetheless, the Soviet economy collapsed in The Soviet Union was dissolved, and the new president of the Russian Republic, Boris Yeltsin, was left to start the difficult task of transition to a market system.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 36 of 45 THE TRANSITION TO A MARKET ECONOMY SIX BASIC REQUIREMENTS FOR SUCCESSFUL TRANSITION Economists generally agree on six basic requirements for a successful transition from socialism to a market- based system: (1)macroeconomic stabilization; (2)deregulation of prices and liberalization of trade; (3)privatization of state-owned enterprises and development of new private industry; (4)establishment of market-supporting institutions such as property and contract laws, accounting systems, and so forth; (5)a social safety net to deal with unemployment and poverty; and (6)external assistance.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 37 of 45 THE TRANSITION TO A MARKET ECONOMY Macroeconomic Stabilization To achieve a properly functioning market system, prices must be stabilized. Deregulation of Prices and Liberalization of Trade An unregulated price mechanism ensures an efficient allocation of resources across industries.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 38 of 45 THE TRANSITION TO A MARKET ECONOMY Privatization tragedy of commons The idea that collective ownership may not provide the proper private incentives for efficiency because individuals do not bear the full costs of their own decisions but do enjoy the full benefits. Private ownership provides a strong incentive for efficient operation, innovation, and hard work that is lacking when ownership is centralized and profits are distributed to the people.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 39 of 45 Which of the following is an initiative for countries in transition to avoid the tragedy of commons? a.Macroeconomic stabilization. b.Deregulation of prices and liberalization of trade. c.Privatization. d.Market-supporting institutions. e.A social safety net and external assistance.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 40 of 45 Which of the following is an initiative for countries in transition to avoid the tragedy of commons? a.Macroeconomic stabilization. b.Deregulation of prices and liberalization of trade. c.Privatization. d.Market-supporting institutions. e.A social safety net and external assistance.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 41 of 45 THE TRANSITION TO A MARKET ECONOMY Market-Supporting Institutions The capital market, which channels private saving into productive capital investment in developed capitalist economies, is made up of hundreds of different institutions. Social Safety Net This social safety net might include unemployment insurance, aid for the poor, and food and housing assistance.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 42 of 45 Which of the following are market supporting institutions? a.Private property. b.The right to profits. c.The enforcement of contracts and property rights. d. All of the above.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 43 of 45 Which of the following are market supporting institutions? a.Private property. b.The right to profits. c.The enforcement of contracts and property rights. d. All of the above.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 44 of 45 THE TRANSITION TO A MARKET ECONOMY External Assistance Very few believe the transition to a market system can be achieved without outside support and some outside financing. Shock Therapy or Gradualism? shock therapy The approach to transition from socialism to market capitalism that advocates rapid deregulation of prices, liberalization of trade, and privatization.

CHAPTER 23: Economic Growth in Developing and Transitional Economies © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 45 of 45 brain drain capital flight capitalist economy communism debt rescheduling export promotion fertility rate import substitution International Monetary Fund (IMF) market–socialist economy REVIEW TERMS AND CONCEPTS mortality rate natural rate of population increase shock therapy social overhead capital socialist economy stabilization program structural adjustment tragedy of commons vicious-circle-of-poverty hypothesis World Bank