Copyright © 2006 Pearson Addison-Wesley. All rights reserved. Chapter 4 Contemporary Models of...

Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

Chapter 4

Contemporary Models of Development and Underdevelopment

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. 4-2

New Growth Theory: Endogenous Growth

Motivation for the new growth theory– Technological Progress as an exogenous factor– i.e. main cause of growth goes unexplained

The Romer model (Paul Romer, 1986, a Ph.D. thesis offshoot)



The Romer model Idea: Capital includes knowledge capital, some of

which – in principle - has a public good character and will diffuse in technology spillovers

Consequence: an increase in the average capital stock of all sectors of an economy increases the productivity of each sector

Increasing returns to scale at an aggregate level



The Romer model

Y AK L Ki i i 1(4.1)

Y AK L 1 (4.2)

1

nng (4.3)


New Growth Theory

Criticisms:– Still relies on many „perfectness“ assumptions

and simplifications not relevant for developing countries


Underdevelopment as a Coordination Failure

Coordination failures occur when agents’ inability to coordinate their actions leads to an outcome that makes all agents worse off

We’ll consider– “Big push” models– The ‘O-ring’ model

The “meeting-in-a-restaurant-problem” as a generic example


Coordination failures: examples

Complementary investments– R&D spillovers– Network of firms– Human capital and firms demanding it

Complementary specialization– From subsistence to market agriculture

A role for a “big player” able to commit


Multiple Equilibria: A Diagrammatic Approach

Generally, these models can be diagrammed by graphing an S-shaped function and the 45º line

Equilibria are– Stable when the function crosses the 45º line

from above– Unstable when the function crosses the 45º line

from below


Figure 4.1


Starting Economic Development: The Big Push

Sometimes market failures lead to an a priori role for public policy intervention

The general intuition– A firm creating demand by paying (high) wages

is only receiving a small part of this demand as demand for its own products

– Moods, expectations or government incentives or demand may be necessary!


Starting Economic Development: The Big Push: Assumptions

Assumptions of this specific model Perfect competition in traditional sector, natural monopolies

(increasing returns!) in the modern sector Only labor as a factor, in trad. Sector, one worker produces

one unit of output w = 1 in traditional sector w > 1 in modern sector Increasing returns modeled through to minimal worker

requirement F Each good is receiving a constant share of demand P = 1 in both sectors (entry deterrence!)


Graphical Analysis


Other Cases in Which a Big Push May Be Necessary

Intertemporal effects: intertemporal demand externality

Urbanization effects: if demand for modern sector goods is primarily urban

Infrastructure effects,Training effects: joint use of intermediate input


Why the problem cannot be solved by a “super-entrepreneur”

Imperfect capital market Too large agency costs (monitoring,

inefficiencies) in the super-firm Inefficient competition for the role of super-

entrepreneur


Further Problems of Multiple Equilibria

Inefficient advantages of incumbency: Getting stuck with an outmoded technology of a monopolist

Behavior and norms: Being good pays if everybody is good

Inequality, multiple equilibria, and growth– High inequality harms especially through imperfect credit

markets (entrepreneurship, education) Linkages as a tool to target government intervention

– Backward, forward, final-demand


Kremer’s O-Ring Theory of Economic Development

Ideas: Quality of production is determined by highly complementary tasks: The weakest link determines quality!

Workers of different quality are not substitutable

Central result: Assortative matching of workers to firms

May also apply across firms!


Implications of the O-ring theory

Investment of any one in skills may be dependent on investment of all

High income and low income clusters (nations, regions, ...)

Extreme income differences between clusters

Brain-Drain!


Figure 4.3


Concepts for Review

Agency costs Agent Aid failure Asymmetric information Big push Complementarities Complementary

investments

Congestion Coordination failure Deep intervention Endogenous growth

theory Linkage Multiple equilibria New growth theory O-ring model


Concepts for Review (cont’d)

O-ring production function

Pareto improvement Pecuniary externalities Poverty trap Prisoners’ dilemma Public good

Romer’s endogenous growth model

Solow residual Technological

externalities Underdevelopment trap Where-to-meet dilemma

Copyright © 2006 Pearson Addison-Wesley. All rights reserved. Chapter 4 Contemporary Models of...

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