Chapter 18 Development Economics Economics, 7th Edition Boyes/Melvin.

Chapter 18

Development Economics

Economics, 7th Edition

Boyes/Melvin

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Big Discrepancies

• The average life expectancy in Botswana is 39 years.

• 70 percent of the population in Cambodia has no access to safe water.

• 45 percent of the population in Ghana exists on less than $1 per day.

• Students in Chad average only 4 years of formal education.


Developing and Developed Economies

• About ¾ of the world’s people live in less-developed countries (LDCs) or Third World countries characterized by low per capita GDP.

• “First World countries” are the highly industrialized nations of western Europe and North America.

• “Second World countries” are eastern European countries and the countries of the former Soviet Union.


The World by Stage of Development


Poverty

• Considered in the absolute sense:– In the U.S., the poverty level for a family of four in 2006 was an

annual income of $20,000 or less.– The World Bank uses per capita GNP of $766 or less as its

criterion for a low-income country.

• Poverty is also a relative concept, making it difficult to compare across countries.– The income of many households in the U.S. who are considered

poor is substantially higher than the incomes of poor families in other countries.


Other measures

• Although economists disagree on a definition of basic human needs, the general idea is to set minimal levels of:– Caloric intake– Health care– Clothing– Shelter

• Physical quality-of-life index uses life expectancy, infant mortality, and literacy standards but does not account for justice, personal freedom, environmental quality, or employment


Political Obstacles to Growth

• Lack of Administrative Skills

• Political Instability and Risk: a country must be able to guarantee private property rights with no threat of expropriation to encourage private investment.

• Corruption: reduces growth most directly through government investment in projects with low productivity.

• Good Economics as Bad Politics


Corruption Perception Index

• Transparency International, a global coalition against corruption, produces an annual Corruption Perception Index report.

• A country’s CPI Score relates to perceptions of the degree of corruption as seen by business people and country analysts and ranges between 10 (highly clean) and 0 (highly corrupt).

• In 2005, Iceland ranked as least corrupt while Chad ranked as most corrupt.


Social Obstacles to Growth

Lack of Entrepreneurs– In developing countries, entrepreneurs tend to be

immigrants who have skills and experience that do not exist in poor countries.

– In some societies, traditional values that do not encourage high achievement may be an obstacle to development.


Social Obstacles to Growth (2)

Rapid Population Growth

– Capital shallowing occurs when growth reduces the amount of capital per worker, lowering the productivity of labor.

– Age dependency occurs when growth produces a large number of dependent children, whose consumption requirements lower the ability of the economy to save.

– Investment diversion occurs when growth shifts government expenditures from the country’s infrastructure (roads, communication systems) to education and health care.


Population Growth in Less Developed Countries

• World population is expected to rise 2.6 billion in the next 45 years.

• Nearly all of the growth will take place in the less developed countries.

• Sub-Saharan Africa, the world’s poorest region, is the fastest growing.


Inward-Oriented Strategies for Development

• Developing countries have a tendency to drift toward exports of primary products (natural resources, raw materials, or first-stage products) to sell in in foreign markets.

• Inward-oriented strategies focus on developing products that can be sold in domestic markets, avoiding the need to import manufactured goods. This is called import substitution.

• Import-substitution policies are enacted by countries seeking industrialization.


Outward-Oriented Strategies for Development

Export substitution is the use of resources to produce manufactured products for export rather than for the domestic market .– Used in countries with abundant, high-quality

labor to produce labor-intensive goods.– Efficient, low-cost production competes

effectively against producers in other nations.– Tax breaks and loans are offered for

exporters, gov’t assistance in int’l marketing.– Gov’t discourages domestic sales of

resources.


Comparing Strategies• In the 1950s and 1960s, many economists

argued that exports of primary products results in deteriorating terms-of-trade: Over time, exports would buy less and less imports.

• Countries moved toward inward-oriented strategies in response to this argument.

• Critics argue that resources should be free to move to their highest-valued use and that market-driven resource allocation is unlikely to occur in an inward-oriented economy.


Comparing Strategies• Some economists believe that developing

countries require active government intervention and regulation of economic activity. They believe that resources in these countries are unlikely to move freely to their highest-valued use if free markets are allowed.

• They focus on the structure of developing countries in terms of uneven industrial development. A single economy with industries at very different levels of development is called a dual economy.


Foreign Savings FlowForeign Direct Investment (FDI): The purchase of a physical operating unit that gives the domestic firm more than a 10% control of the foreign firm.Portfolio investment: The purchase of securities.Commercial bank loan: A bank loan at market rates of interest, often involving a bank syndicate. Trade credit: The extension of a period of time before an importer must pay for goods or services purchased.


Benefits of FDI

• Jobs– Often FDI is encouraged in industries in which

the country has inadequate capital or technology.

• Technology– Investment by firms from HDCs brings the

results of R&D in the form of advanced technologies.

• Foreign Exchange Benefits


Outsourcing creates Jobs for Developing Countries

• The German firm Siemens recently moved 15,000 software programming jobs from the United States and Western Europe to India, China and Eastern Europe.

• Many Western countries farm out software development and back-office work to India and other countries, where wages are significantly lower.

• India earns over $13 billion annually from the outsourcing of such services.


Foreign Aid• These are gifts or low-cost loans made to

developing countries by another country.

• Bilateral Aid: one country gives aid to another

• Multilateral Aid: aid provided by international organizations drawing on resources from many nations (World Bank, etc.)


Transition from Socialism• Privatization

– converting state-owned enterprises (SOEs) to private ownership

• Price Reform– A market system requires that prices be free to

fluctuate to reflect supply and demand changes.

• Social Safety Net– What about health care, unemployment, crime,

political unrest, etc.?


Transition from Socialism (2)Macroeconomic Issues:

• Monetary Overhang (Forced Saving): money accumulated by households because there was nothing to buy

• Currency convertibility: The ease with which the domestic currency could be converted into foreign currency at equilibrium rates of exchange

• Money and Credit

• Fiscal Policy: removing subsidies, fighting deficits, allowing inefficient firms to die, establishing taxes on an appropriate tax base.

Chapter 18 Development Economics Economics, 7th Edition Boyes/Melvin.

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