1. Development Economics III Prof. Dr. Hans H. Bass Jacobs University, Spring 2010

2. Feb. 18, 20102 Development Economics Agenda Feb. 18 1.Causes of and Strategies for Development: Traditional... 1.1 Creating preconditions for take-off 1.1.1 Stages of growth 1.1.2 Harrod/Domar growth model 1.2 Structural change and modernization 1.2.1 Dual labor market model 1.2.2 Patterns of development 1.3 Overcoming dependency 1.4 Getting the prices right 2.... and New

3. Feb. 18, 20103  historical analogy 1. traditional society 2. pre-conditions for take-off into self-sustaining growth 3. take-off 4. drive to maturity 5. age of high mass consumption  “These stages are not merely descriptive. [...] They have an inner logic [...]” (W. W. Rostow 1960)  “Theory of Economic Growth” 1 Causes of and Strategies for Development: Traditional 1.1 Creating preconditions for take-off 1.1.1 Stages of growth Stages of Economic Growth

4. Feb. 18, 20104 1 Causes of and Strategies for Development: Traditional 1.1 Creating preconditions for take-off 1.1.1 Stages of growth Take off (Rostow)  I / GNP* > 10 %  I = S domestic + S external Example Japan 1880  1930: 12%  25%  At least one leading sector (  unbalanced growth with linkages) above average growth of demand and supply  income elasticity of demand ε D,Y and... supply ε S,Y both > 1 significant share in the economy transmittance of technological key innovations to other industries strong backward and forward linkages Example Japan: railways, textiles (cotton)  Establishing the political, social and institutional framework conditions for a modern industrial society

5. Feb. 18, 20105 1 Causes of and Strategies for Development: Traditional 1.1 Creating preconditions for take-off 1.1.2 Harrod-Domar growth model Harrod-Domar growth model national income Y = f (K, L), g Y = ∆Y / Y savings  investment (Y=C+S and Y=C+I) savings S = s Y (attitudinal relation) net investment I = ∆K capital-output ratio k = K / Y (technical relation) or: k = ∆K / ∆Y or: ∆K = k ∆Y S = I or: S = s Y = k ∆Y = ∆K = I or: s Y = k ∆Y ∆Y / Y = s / k

6. Feb. 18, 20106 Harrod-Domar growth model In order to grow, economies must save and invest a certain proportion of their GNI g Y = s / k  The more they can save and invest, the faster they can grow  However, the actual growth rate for any level of savings and investment is determined by 1/k (the inverse of k, i.e. capital productivity!) Example: s = 6%, k = 3, g Y = 2%  take-off: s = 15%, k = 3, g Y = 5% 1 Causes of and Strategies for Development: Traditional 1.1 Creating preconditions for take-off 1.1.2 Harrod-Domar growth model

7. Feb. 18, 20107 Harrod-Domar growth model in practice The savings gap can be filled by foreign aid, FDI, or loans (  Marshall Plan II) or forced saving (!) However, capital accumulation necessary, but not sufficient condition (Marshall plan II ≠ Marshall plan I)  economic myopia 1 Causes of and Strategies for Development: Traditional 1.1 Creating preconditions for take-off 1.1.2 Harrod-Domar growth model

8. Feb. 18, 20108 Dual labor market model  W. Arthur Lewis + Fei / Ranis, 1960s / early 1970s  Two sectors: I) traditional, overpopulated rural subsistence, zero marginal productivity of labor (“surplus labor”), wage rate according to average product, unlimited supply of labor II) modern industrial sector, profit-maximizing behavior of enterprises, wage rate according to marginal product, perfectly wage elastic supply of rural labor (supply curve: subsistence wage plus premium) all profits being reinvested  upward spiral of self-sustaining growth until modernization completed 1 Causes of and Strategies for Development: Traditional 1.2 Structural change and modernization 1.2.1 Dual labor market model

9. Feb. 18, 20109 Criticisms  no labor saving technology considered: possibility of anti- developmental economic growth (increased inequality)  often no surplus labor in rural areas  until 1980s: tendency of urban wages to rise in spite of open modern-sector unemployment  diminishing returns in the modern sector questionable (  New Growth Theory, external effects, but complementary state investment in infrastructure etc. necessary) 1 Causes of and Strategies for Development: Traditional 1.2 Structural change and modernization 1.2.1 Dual labor market model

10. Feb. 18, 201010 Dual labor market model in practice  neglect of agriculture  neglect of urban informal sector 1 Causes of and Strategies for Development: Traditional 1.2 Structural change and modernization 1.2.1 Dual labor market model

11. Feb. 18, 201011 Patterns of development analysis  Hollis Chenery et al. (late 1970s, early 1980s)  Similarity to simple stage models: development = sequential process, S↑ I ↑ necessary  Difference: S↑ I ↑ not sufficient!  Structural changes in socio-economic factors necessary  In practice: struggling for the right mix of policies  Criticism: lack of theoretical rigor can lead to wrong intervention in assumed causal chains 1 Causes of and Strategies for Development: Traditional 1.2 Structural change and modernization 1.2.2 Patterns of Development

12. Feb. 18, 201012 Dependency Theory  1970s, 2000f. (anti-globalization movement)  Causes for under-development: neo-colonial dependence, intentionally exploitative or unintentionally neglectful attitude of First World to Third World  Underdevelopment externally induced  In practice: De-linking, state-owned enterprises, and industrial nationalism (import substitution industrialization strategy ISI) / collective self-reliance  Criticism: Experiences all negative 1 Causes of and Strategies for Development: Traditional 1.3 Overcoming Dependency

13. Feb. 18, 201013 Market Fundamentalism  1990s  Causes for under-development: incorrect pricing policies  too much state intervention, poor resource allocation New Political Economy  minimum government is best  Under-development internally induced  In practice I: Privatization, reduction of state intervention, integration into the world economy according to static comparative advantages  In practice II: “Market-friendly approach”, non-selective interventions, suitable climate for private enterprises  Criticism: Positive development examples were non-fundamentalist during take-off (Germany, USA, Japan... Taiwan, South Korea, China) and developed dynamic comparative advantages by state involvement 1 Causes of and Strategies for Development: Traditional 1.4 Getting the Prices Right

14. Feb. 18, 201014  each approach has its strengths and weaknesses (see case study on ROK and Argentina)  no universally accepted paradigm  traditional approaches have informed new, eclectic approaches Causes of and Strategies for Development Conclusion