Development Economics: An Introduction WiSe 12/13

1 Key Problems of Economic DevelopmentInterrelated Problems of Economic Development:

Poverty, Education, Inequality, Population Growth, HIV/AIDS, Resource degradation, climate change, Migration, Urbanization, International trade issues.

Poverty and Hunger:Interrelated dimensions: Hunger, malnutrition and low life expectancy, limited access to key resources. Less educational opportunities. No participation. Increasing vulnerability

1 Millenium goal: Eradicate extreme poverty and hunger4 Millenium goal: Reduce by ⅔ child mortality

Malnutrition is worlds most serious health problem.Reasons for hunger:

Inappropriate agricultural policies Disregard of agriculture and rural development in DC Subsidies in developed countries (Unfair competition) Bio­Fuel production (Crops used for fuel instead of nourishment)

Limited access to markets (Fertilizers, technology, etc) Natural events (Floods, droughts) Conflicts

Almost all undernourished people (98%) live in DC.

Education2 Millenium goal: Achieve universal primary school education

Inequality3 Millenium goal: Promote gender equality and empower women

Women attend less to schools, lower job opportunities and are unevenly represented in national parliaments. Depends on Region (In Qatar no representation at all).

Population Growth:Population Growth to be expected. Almost all increase in DC.(Potential) negative consequences of Population Growth:

Lower per capita income growth Increase in poverty and inequality Food crisis

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Environmental degradation Internal migration Gaps in education Insufficient health services

HIV/AIDS and diseases95% of all HIVs live in DCs (specially Sub­saharan Africa)DCs more affected by diseases because of povertyPoor health conditions affect negatively productivity ( → wages↓).

Environmental degradationThere has been a lot of soils that lose all of their productivity.Absolute poverty is a driving force behind environmental degradation.Causes:

Most environmental destruction has been caused by the developed world. CO2, Resource exploitation

The poor are greatly affected as their livelihoods depend on NR. No access to technology & agricultural inputs Lack of knowledge about more sustainable management practices

2 Poverty and Inequality: Definition, Measurement, Implications2.1 Inequality2.1.1 Definition of Inequality:= Unequal distribution of income, consumption expenditures, assets, socioeconomic factors among households

Simplest way of measuring is dividing population and calculate how much is allocated to each population share.

2.1.2 The Lorenz Curve

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2.1.3 Gini CoefficientDerived from the lorenz Curve. 0 = Perfect equality; 1= Perfect inequalityArea Under the lorenz curve divided by lower triangle

Why is inequality an issue? Regarded as unfair Social welfare depends negatively on poverty and inequality Important to understand depth of poverty Growth may be only accessible for the elite (No Trickle Down Effect) High inequality undermines social stability and solidarity Leads to economic inefficiency → Lower income and economic growth

Less people qualify for loans Lower savings and investments Unequal power distributions (Rent seeking) Marginal utility gains are higher for poor people

2.2 Poverty2.2.1 Definition of Poverty and its Dimensions“Poverty is pronounced deprivation in well being” Poverty is a multi­dimensional problemWell being:

Command over commodities Can people fulfill the need for specific goods? Generated by capability to function in the society (Amartya Sen, 1987)

“Poverty, in this view is not ultimately a matter of incomes at all; it is one of a failure to achieve certain minimum capabilities. The distinction is important since the conversion of real incomes into actual capabilities varies with the social circumstances and personal features.” Amartya Sen

Capabilities: Set of alternative being and doing that a person can achieve with his or her economic, social and personal characteristics. Examples: Freedom from starvation, participating in communal life: shelter, freedom to travel and see friends...

It is absolute and not relative [!!] (If a lot of other people are poor that does not make you any less poor yourself)

Livelihood conceptLivelihood = means of livingLivelihood comprises the capabilities, assets and activities required for a means of living

Dimensions of poverty: Malnutrition, low income, low life expectancy, limited access to

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education, knowledge, drinking water and health services, inadequate shelter, low participation in political, economic and social processes.

2.2.2 Selective Poverty IndicatorsIncome Poverty:

Advantages: Quantitative poverty analysis, includes non­monetary income and expenditure elements (e.g: Household and subsistence production)Problems: Datenerhebungsverfahren different between countries

Human Development IndexCombines per capita income with health and education indicator

[There was a change in 2010 (mathematical)]The closer to 1 the more developed.

Advantages: Inclusion of Human Capital Multi­dimensional Good data availability

Problems: Data collection cumbersome (Census) and subject to measurement errors

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School enrollment ≠ school attendance Missing Dimensions

Ecological indicators Relevance of indicators

Aggregated values

VulnerabilityExposure to income/health risks in one period and probability of exposure to further risks

Problems: Calculation of indicators, Vulnerability dependent on (unknown) household wealth conditions

Voicelessness and powerlessnessIdentification of institutions which are important to participate in economic and political decision making

Problems: Comparing data between countries and no standardized measures between countries

2.2.3 Absolute and Relative PovertyAbsolute poverty: Rate of people who are not able to mobilize sufficient resources to secure their basic needs. People who live below a specific real income level

The proportion of people living on less than $1.25 a day fell from 47% in 1990 to 24% in 2008. Much progress in China, India and southern Asia.

Relative Poverty: Fulfillment of basic needs is considerably lower compared to a reference group.It does not imply absolute poverty. The poverty threshold is arbitrarily chosen.

2.2.4 Poverty LinePoverty Line: Minimum amount of the chosen indicator which separates the poor from the non­poor.

Common methods: Food­energy intake Cost of basic needs approach Subjective poverty lines

There are also lower and upper bound poverty lines, because there are also non­food essentials.

Problems with poverty lines: Poverty line does not show the intensity of poverty

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Troublesome to determine a correct poverty line Where is poverty line Differences in consumption requirements Different goods baskets Price differences

2.2.5 Poverty MeasuresPoverty MeasuresSteps:

Define indicator Develop Poverty Line Generate summary statistics

Headcount Ratio (HR) / Headcount IndexAbsolute or relative (HR) number of poor individuals (H).H = ∑ I if (Yi < Yp)HR = H/N

Easy to understand, BUT: Does not consider intensity of poverty (To which extent individuals fall below the poverty

line) Does not consider distribution below poverty line Non­monetary indicators?

[I don’t think this are relevant. Should just be noted that intensity of poverty is taken into account ]Total Poverty Gap (TPG)Takes intensity of poverty into account.TPG measures “The total amount of income necessary to raise everyone who is below the poverty line up to that line”. TPG = ∑ (Yp ­ Yi )Per capita measure can be achieved by dividing by total population (APG)

Average Income Shortfall (AIS)Average amount by which a poor person’s income falls below the poverty line.AIS = TPG/H

Can also be expressed as normalized income shortfall (NIS) how big is the average fraction of the shortfall of the income of a poor individual in relation to the poverty line.NIS = AIS/Yp

Poverty Gap Index (NPG)

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Average poverty gap relative to poverty line Yp . NPG = APG/Yp

takes into account intensity of poverty

Squared Poverty Gap Index (NPG2)Weighted sum of poverty gaps in relation to the poverty line.The extreme poor are weighted more (info about severity of poverty)Takes into account inequality among the poor.

Foster­Greer­Thorbecke Index (FGT)Summarizes HR, NPG and NPG2

Pα = 1/N * ∑ ((Yp ­Yi )/Yp)^α

α = 0 → HR Shows only how many people are poorα = 1 → NPG Takes into consideration intensity of povertyα = 2 → NPG2 More weight given to poorer individuals (Inequality among the poor)

2.2.6 Rural and Urban PovertyPoverty is more concentrated in rural areas where they have low quantities of land.In rural areas the majority depend on agricultural instead of industry and services.

People in rural areas are isolated from markets, have poor infrastructure.The migration of rural people to urban areas create slums.

Policy Problem: Largest share of investment in DC were in Urban Areas (Not rural)

3 What is “Development”?Controversial.

1950­70s: Development = Growth.BUT: Growth is necessary for development but not sufficientImprovement in other aspects of human welfare

Developing CountryNo uniform definitions (Big differences between DCs)By World Bank: Lower Income Countries and Lower­middle Income Countries ($4000 or less per capita)

4 Actors in Development Cooperation4.1 International (multilateral) Organizations

The World Bank Group (Owned by 188 member countries) IBRD: International Bank for Reconstruction and Development

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Long term Credits IDA: International Development Association

Softer loan conditions for low income countries = narrow sense of Worldbank IFC: International Fiannce Corporation MIGA: Multilateral Investment Guarantee Agency ICSID: International Centre for Settlement of Investment Disputes

International Monetary Fund Supervision of national exchange rate and economic policies, financial support

Regional Development Banks UN Organizations

UNDP (Development Programme), FAO (Food and Agriculture Organization), WFP (World Food Programme)

European Union Reduce poverty, sustainable development, democracy, peace and security

4.2 National (bilateral) Organizations Bundesministerium für Wirtschaftliche Zusammenarbeit und Entwicklung (BMZ) Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) Deutscher Entwicklungsdienst (DED) Kreditanstalt für Wiederaufbau (KfW)

5 Development Theories: A Synopsis5.2 Classification

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5.3 Non­economic theories of development5.3.1 ClimateGeographical/Climatic differences explain unequal states of development throughout the world. Poorest countries are almost all in the tropics

Montesquieu(1748): Willingness to work increases as distance from equator increases

Esther Boserup (1965), Günther Hesse (1982): Climate is key to understand changes in economic systems. Necessity to produce surplus in Winter → Free time in Winter for manufacturing

Critique: Only one explanatory factor. Today’s climate is not particularly harmful.

5.3.2 Socio psychologicalSocial dispositions support economic and social developmentMax Weber (1904): Calvinist ethic pushed development of capitalismH. Hagen (1962): Traditional (stiff) societies not fertile for entrepreneurship

Critique: Little focus on economic development. What happened with non­hierarchical African societies?

5.3.3 Theories of ModernizationIndustrialised countries are blueprint of modern societies while developing countries fell behind

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on their way.

Critique: No culture­specific concepts of development allowed. Development is synonym for western style organisation of society/ economy

5.4 Classical Theories5.4.1 Linear Stages TheoriesBackground: WWII, Success of Marshall PlanAgrarian DCs will eventually transform into modern ICs.Underdeveloped countries are stuck in “precondition for take­off” while advanced countries are past “take off” and into “self­sustaining growth”

Strategy for development: Mobilisation of domestic and foreign savings → generate investment → accelerate growth

Rostows’s stages of Growth:

Practical implications:

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Recommendation of structural adjustment programmes to accelerate social change Active State provides legal framework (stability) and imposes economic incentives:

taxes, subsidies Democratisation Influenced WB and IMF policy in the 80s/90s

Critique: Little explanatory power (How does development take place?) No explanations of deviations from linear model Role model of IC disputable Categorisation of stages by random criteria Poor empirical performance Disregard of exogenous explanatory variables

5.4.2 Structural Change ModelsIdentifies obstacles to development and suggests mechanisms on how to transform economy from agriculture to industry using tools of neoclassical price and resource allocation theory.

Classical dualism: Why sectors exist at different stages of developmentNew Dualism: Examines more closely the process of transformation a traditional into a modern sector.

5.4.2.1 Classical DualismModern/industry/exogenously imposed vs traditional/agriculture/endogenously grown

Self reinforcing technological dualism:There are different production functions in advanced and traditional sectors (Higgins 1968), Eckstein (1955). Employment problems due not to lack of demand for produced goods but technological problems.

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In the traditional sector: Labor intensive, factors are exchangeableIn modern sector: Only limited degree of substitutability between factors (capital intensive production)

Only by an increase in capital stock can excess labor be employed!

Critique: Strong simplification. insufficient empirical proof, many linkages between sectors which are not considered, industry is not necessarily the driving force of economic growth.

5.4.2.2 New DualismLewis’ Two­Sector Model:Labour migration from surplus labor to high productivity modern sectorSubsistence economy → modern industrialised economyspeed depends on investments

Reinforcing process: self­sustainable growth until all surplus labour is absorbed into modern sector

[After a certain point, Human Labour does not bring additional output in the agricultural sector (Diminishing marginal returns). All labour available beyond this point (La) will be surplus labour (labour that is not needed). This does not happen in the modern sector which is able to absorb all this surplus labour. As the modern sector is available to make profits, these are supposed to be reinvested in the sector, thus increasing productivity (Shifting the curve outwards) and thus being able to absorb even more surplus labor. This investment/increase in productivity makes

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the growth to be self­sustaining]

Criticism: Profits might be transferred to abroad (Capital Flight) Assumption of rural surplus labor while there is full employment in the urban areas is

generally not valid (High unemployment in urban industry sector) Assumption of constant real urban wages is unrealistic. In real life, profits are reinvested in labor saving technologies (labor demand

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doesn’t increase proportionally to capital accumulation)→ “Anti Developmental” Economic growth

5.4.2.3 Vicious Circle Theories5.4.2.3.1 Vicious Circle of Capital Demand & Supply (Gunnar Myrdal)Virtuous circle in industrialised sectors (High S, High I → Expansion!)Vicious circle in agricultural sector (Low S, Low I → Underdevelopment!)

→ Poor regions become poorer and rich regions richer!→ Call for active role of State

Virtuous Circle Vicious Circle

Critique:

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Only valid with behavioral assumptions and no perfect substitution of factors of production

No proof that this is a “natural law” that cannot be changed Does not clarify how to break circle

5.4.2.3.2 Balanced Growth (Rosenstein­Rodan, Nurkse)To overcome vicious circle of capital demand, all branches must expand at the same pace → Balanced growth→ Keynes!

Critique: Too much confidence in state’s capacity for planning The Use of Knowledge in Society ­ Hayek <3 No insight into nature and dynamic of capital accumulation Disregard of price as regulating mechanism for optimal allocation Volume of state investment can hardly suffice to trigger a self­sustaining process of

growth

5.4.2.3.3 Unbalanced Growth (Hirschmann, Streeten)Disequilibria caused by active policy intervention can initiate entrepreneurial activityExcess Demand/ Excess Supply→ Self­sustaining chain of disequilibria!

[The idea is that there is enough capital but no readiness to invest. If we increase their readiness to invest there will be growth. when there is excess demand, the profit motive causes incentives to expand production. When there is excess supply prices there is more competition and thus lower prices!. This process is caused deliberately through active policy intervention. This is supposed to be a self­sustaining chain of disequilibria]

Critique: Unrealistic assumption of rational entrepreneurs and bureaucrats Optimal magnitude of disequilibrium? May cause dualistic economies Little attention paid to division of labour Monocausal approach International trade? No integration of agricultural sector into the argument Empirical fact: Countries with high income inequality normally have small growth rates

5.4.2.4 Neocolonial Dependence Model5.4.2.5 Dissociation5.4.3 Demographic Theories5.4.4 Foreign Trade Theories

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International trade is major force in development. While it is usually favourable for both countries, the rents may be distributed unequally

5.4.4.1 Prebisch­Singer Terms Of Trade (ToT)There is a secular (long term) decline in the ToT of primary commodity exporters resulting in a transfer of income from poor to rich countries.

ToT: Ratio of export and import price indexes (ToT = Px/Pm) Number of imported goods that a country can buy by selling an export good

Reasons for decline in ToT: Low Income Elasticity of demand for primary commodities in ICs (<1) High income elasticity of demand for manufactured commodities in DCs (> 1) Unequally distributed technological progress (TP)

Imports become more expensive for DC Unequally distributed bargaining power

Critique: How you measure price influences change of ToT (Different results with Laspeyres and

Paasche!) Change of quality of goods might also lead to a change in ToT Time Series not representative No consistent empirical pattern Not all exporters of primary goods are DCs (Australia, Canada)

→ Prebisch­Singer hypothesis does not hold!

5.4.4.2 Immizerizing Growth (Bhagwati, expanding on Prebisch/Singer)Growth leads to increased demand for imports from ICs. To afford them DCs have to increase its foreign currency stock by augmenting its exports

Negative ToT effect crowds out positive growth effect.Gains of growth are transferred to trading partners (ICs) in the form of consumer rents

→ Immiserizing growth

Critique: Extreme circumstances assumed Many DCs are price takers

Changes in exports do not influence Pw

ToT effect only materializes in case of parallel growth of exports in many DCs

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The higher the export good is placed in the chain of economic value added, the more income elastic is ICs demand, the less plausible the hypothesis

Brazil as exception

5.4.4.3 Import SubstitutionMain Idea: Substitute imports with domesticsSteps:

Identification of target goods (large domestic markets) Protectionism (Infant Industry) Growth/Maturation Re­entrance in world markets

[The idea here is that if some products did not have to compete with international prices, they have a demand they previously didn’t have, and are able to learn and grow as companies. They only want to protect the industry until it is mature enough. After a certain threshold the barriers can be removed and they can trade again and reap the benefits]

Critique: Most countries didn’t succeed (Latam)

Too small domestic markets Low competition (monopolies) Low quality didn’t survive in international markets

5.4.4.4 Export Promotion“Outward looking strategy”ABOLISH REGULATIONS OF FOREIGN TRADEExample: Asian TigersAlmost all countries with high export growth rates exhibit high overall growth rates (But: Causality ?)

5.5 Growth Theories5.5.1 The Harrod­Domar model (Post­Keynesian)S = IEconomic growth is positive if investment exceeds amount necessary for replacing depreciated capitals↑ → g↑ (Higher savings lead to higher growth rate)Θ↓ → g↑ (A lower capital­output ratio leads to a higher growth rate)

Gives an easy formula for growth positive correlation between investment quota and GDP growth. Influenced the thinking of countries with central planning

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Criticism: S, Population growth and capital output ratio assumed to be exogenous No explanation of why growth rates differ for different income levels I necessary but not sufficient for growth! World Market? Market and price effects? No diminishing marginal returns

Including population growths↑ → g↑ (Higher savings lead to higher growth rate)Θ↓ → g↑ (A lower capital­output ratio leads to a higher growth rate)n↓ → g↑ (Less population growth leads to higher per capita growth rate)δ↓ → g↑ (a lower depreciation rate leads to a higher per capita growth rate)

Endogeneity of savings:Low savings rates are likely if people have income close to subsistence level→ Difficult for governments to raise savings rate (Other growth sources needed!)As economy grows more savings become possibleSome inequality encourages savings among middle class (Prestige and status)Tendency for declining savings rate of the richSavings rate changes with income→ Growth rate of low/high income countries lower than middle income countries

Endogeneity of population growth:Population growth rates vary with level of per capita incomePoor countries have high death & birth rates (low population growth rate)Increasing living standard leads to falling death rates → Increased population growth

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[As population growth is supposed to depend also on per capita income, a temporary push to surpass point B can lead to sustainable growth. All Points below B tend to end up in A (Trap). Between A and B the population growth eats up the income growth (Economy becomes poorer)]

Strengths and critique: Easy to use (+) Focus on the key role of saving

Not enough! (­) Rigid assumptions (fixed capital­to­labor, capital­to­output, labor­to­output) Technological progress?

5.5.2 Solow (Neoclassical theory)Most influential growth model in EconomicsDiminishing marginal returnsCapital­output ratio is endogenousS, δ, n have only level effectsOnly increased tech. progress has a growth effects.unconditional convergence (Because of diminishing marginal returns)5.5.3 Endogenous growth theoriesCriticism towards neoclassical theory

Convergence to 0 per capita growth, exogenous technological progress to explain long run growth

Growth is explained endogenously (end. Techn. Progress)No diminishing marginal retunrsInnovation and/or human capital formation as growth engine

5.5.3.1 Human Capital ModelInvesting time and money in education.Difference in human capital can explain income differences between countries10 Assumptions

Implications:Diminishing marginal returns to physical capital possible without convergence of per capita incomes, if human capital is characterized by increasing marginal returns.→ In the LR, Countries with similar savings and technology grow at the same rate, initial differences will be maintained.

Larger effect than in Solow! and Growth effects not just level effects5.5.3.2 AK Model

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Constant marginal product of capitalY = A*KAs long as S*A > δ → growth! (without Technological progress)No absolute or relative convergence

Critique:Very simple specificationsConstant marginal product of Capital

5.5.3.3 RomerTechnological spill oversKnowledge = Public Good

Productivity gains in one firm lead to productivity gains in other firmsGrowth is endogenous due to positive externalitiesDifferent growth rates of knowledge rich/poor countries!

5.5.3.4 Criticism of endogenous growth theory Depend on some neoclassical assumptions which are often inappropriate for DCs Structural change not modeled Ignores influential factors (Imperfect markets, institutional structures) Limited support of empirical studies

5.5.3.5 New Models of Economic Development ComplementaritiesBehaviours by someone increases the incentive for the same behaviour in others.Increased capital accumulation by one firm causes increased I by others.Expectations about the behavior of other economic agents influence own decision making.

Misallocation due to coordination failureCoordination problem leads to pareto­inefficient equilibrium

Examples for complementary structures: Specialized firms ­ specialized labor

No incentive to acquire new skill without demand, but no incentive to invest in areas without specialized force

Specialization/division of labor in rural areas For specialization middlemen needed, but to be middleman specialized

producers needed!Which comes first? Supply or demand? → Complementary investments at the same time → Policy intervention to achieve best equilibrium!

5.5.3.6 Washington consensusSuggestion for Latam economies (although applied, no economic growth)

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10 Points: Fiscal Discipline Reordering public expenditure priorities Tax reform Liberalization of interest rates’ Competitive exchange rates Trade liberalization Liberalization of foreign direct investment Privatization Deregulation Secure Property rights

Potential reasons for failure: Other factor led to disappearance of growth Slowdown in growth in IC Rise in world interest rates Financial Crisis in developing word 1979 Oil Shock Relative performance may be what matters Incomplete introduction of recommendations

Privatization without competition No full fiscal discipline

Critique: No concept for

Inequality reduction Elimination of absolute poverty

Strictly negative view of government regulatory power (but: China? South Corea?)

5.5.3.7 Recent Growth data5.5.3.8 Limits to growth"Anyone who believes exponential growth can go on forever on a finite planet is either a madmanor an economist." Kenneth Boulding, 1986

Restricted resources vs unrestricted human needs: Peak Oil Declining environmental quality Overuse of resources in IC at the cost of environmental degradation in DC

Limits of Growth:Scenario 1: Crisis of non­renewable resourcesRapidly increasing prices for resource extraction lead to Industrial Output peak.

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Population growth (demand) → pollutionDependency of food production on industrial inputs → degradation of land→ Lower food and industrial production→ Death rates increase and population declines

Scenario 2: Crisis of environmental degradation and pollutionAvailable resources double (limits/peaks are reached later)→ Increased population → increased pollutionDegradation of land that cannot be compensated by industrial inputsdeath rates increaseNo recovery possible

5.6 New Institutional Economics and DevelopmentNeoclassical theory too unrealistic! NIE complements it

“Institutions are humanly devised constraints that shape human interaction.” North 1990

Formal and informalcreated (constitutions) or can evolve over time (common law )Violations have to be detected and there has to be punishment for deviation

Types of institutions: External (enforced, f.e law) (easier to modify) Internal (not enforced, f.e norms, values, ethical rules) (harder to modify)

Functions of institutions: Institutions define the choice set which influences the cost of exchange and production

(transaction and transformation costs) Reduce uncertainty Make the private and social rate of return compatible (Invisible hand, framework)

5.6.1 Transaction Costs (TAK)Transaction cost: Costs of using the market (Information, Decision, etc)Bounded rationality: Limited information processing capacityTrade off between gains of specialization and increasing TC

Challenges in DC due to TC Poor transport, underdeveloped markets Inefficient public administration Poor education Contracts:

Supervision Problems

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Risk carrying capacities

“The inability of societies to develop effective, low­cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment in the Third World...” (North)

5.6.2 Property Rights (PR)NIE and Development Property Rights (PR)

Property rights systems is bundle of rights (usus, fructus, abusus, venditio) PRs determined by legal structures as well as by norms and values PR ensure that today’s investments will generate future returns Clear defined PR help prevent conflict (Rules are clear) No PR cause externalities (f.e: Tragedy of the commons) Absence of PR hinders investment and specialization

ICRG Index (International Country Risk Guide) Expropriation risk and Rule of Law Repudiation of contracts by government

Can government enforce contracts? Proxy for unconstraint in other areas

Corruption in government and quality of bureaucracy: Efficiency and Rent seeking Low Score:

Bureaucracy lacks competence use of other criteria for determining policies Low protection for PR Less capital investment and foreign technology

PR and economic growth Institutions that secure PR are crucial for growth PR influence size and efficiency of investment allocations

5.6.3 Agency Problems Information asymmetries between principal and agent due to TC (monitoring costs)

Ex ante: Adverse Selection Ex Post: moral Hazard

Design incentives to reduce PA problem!Agency Problems in DCs

Principal: Government, Agent: Bureaucrats Natural resources: Principal: Population, Agent: politicians Powerful players take advantage of poor information basis of smallholder farmers Due to lack of collateral: underdeveloped financial services

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Examples of institutional designs to overcome agency problems Reputation and Trust, Family enterprises → trust, Interlinked contracts,

Collaterals, self­enforcing contracts (ostrom)5.6.4 Collective Action

Tragedy of the commons: Non­excludability leads to free riding → Degradation of commons

To overcome Tragedy of the Commons, policy makers must know political economy of collective action (importance of values, norms, rules of behavior...)

Types of property Private property Common property (Rights held by community) State property (Held by the state) Open Access (Tragedy of the commons)

Solution to commons problems State Regulation (Hardin) Privatization Collective Action

Trust can lead to pareto efficient field of prisoner’s dilemma matrix5.6.5 Public Choice5.6.6 Institutional Change5.7 Bibliography

(Neo­) Classic Theories on Economic DevelopmentNew Institutional Economics

6 Population Growth and Economic Development6.1 Population TrendsMore than ¾ of the world population live in developing countries6.2 Demographic Transition

Since 1950 fast slowdown of death rates introduced by import of medical progress Constant high birth rates In LATAM and Asia strongly falling death/birth rates In Africa and Middle East stagnation caused by poverty and AIDS

6.3 Malthusianism Population grows geometrically, production of nourishment arithmetic

CRISIS! (Epidemics, famines and wars inevitable) He seemed to be mistaken

Yield increase per surface unit of land Demographic transition

6.4 Leibenstein / Nelson: Neo­Malthusianism6.5 Critical acclaim7 Environment and Development7.1 Introduction

Environmental Resources important factor for DCs

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Vicious circle between poverty and environmental degradation! Economic growth negatively influenced by environmental degradation Rapid population growth and economic activity → more environmental damage DCs and Global warming

↑Food demand + poverty → Areas for food production → deforestation → more global warming → Losses because of global warming

ICs are most responsible for global pollution, but DCs are more vulnerable

Ecological FootprintWWF and Global Footprint Network

Indicator for sustainability Consumption v Regenerative capacity

Area required to produce the resources people consume Area occupied by infrastructure Area of forest required for sequestering CO2 not absorbed by ocean

Conflicting views Anthropocentric

Human being as center. Nature is necessary but not an end in itself Utilitarian Anthropocentrism: Nature as resource Protectionist Anthropocentrism: Nature is conservation­worthy

Biocentric Nature is an end in itself Incompatible with modern exploitation

7.2 Sustainable DevelopmentSustainability:= “Meeting the needs of the present generation without compromising the needs of future generations.” Todaro, Smith

Sustainable development path: Exists if: Overall capital assets remain constant/rise over time But: Physical and natural capital only substitutes if there is a minimum environmental

capital → Environment should be taken into account

Problems of Sustainability Often: Economic growth vs environmental preservation

Rapid growth → environmental degradation and pollution Improving environment → reduces growth

Possibility of sustainable growth ↓Environmental degradation → Production costs↓ → Output & Welfare↑ ↓ Water and air pollution → Tourism and agricultural production↑

Non sustainable Resource use due to:

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Market failure, incomplete property rights, poverty

7.3 Theory of Resource Allocation Market failure leads to negative environmental externalities

Refers to privately owned resources7.3.1 Static Efficiency

Supply and Demand → Optimum consumption Net benefit to society maximized (MC = MR)

7.3.2 Dynamic Efficiency [NOT THE ONE FROM Wettbewerb und Regulierung] Resources are scarce and rationed over time Saving for tomorrow may lead to increase in prices today

Owner collects scarcity rent Rationing is necessary for efficient allocation over time

Without scarcity P = MC → all units are consumed today7.4 Problems of Efficient Allocation and Solutions

“So long as all resources are privately owned and there are no market distortion, resources will be allocated efficiently.”

What leads to inefficiencies: Market failures

Public Goods Non rivalry and non excludability Free Riding (Because of non excludability)

Individuals can benefit from consuming public good without having to pay for it

No incentive to pay for it! Solutions to Free Riding

Command and control (coercion by govt) Taxes (e.g emission taxes) Incentives (Market approach): Cap­and­Trade, Emissions

permits Externalities

Example: IC generate pollution but DCs pay for it Solution: Internalizing external costs (Bearing costs for it)

Taxes and market approaches (Emission rights) Pigou taxes The more price inelastic party (Producer or consumer)

pays the higher burden Imperfect competition, imperfect information

Imperfect property rights Perfect PR: Universality, Exclusivity, Transferability, Enforceability

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7.5 The Problem of Common Property Scarce resource which is publicly owned and thus freely available to everybody Tragedy of the commons

Free riding until degradation of resource Solutions: Regulation, privatization, collective action or community governance If land is privately owned, there will be fewer workers employed, to collect scarcity

rent, thus less degradation But: Income distribution? Costs of exclusion not considered

8 Trust and Economic PerformanceTrust:= “Willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party.” Mayer et al (1995)

Economic activities that require agents to rely on future action are accomplished at lower cost if there is trust

“Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can by explained by the lack of mutual confidence.” (Arrow, 1972)

When there is no (institutional) trust, social contacts and individual networks are used to do business

Examples for trust­sensitive transactions: Goods today, payments tomorrow (Buying on credit) Agent is difficult to monitor (Peasant farmer doesn’t feed mule he rented) I, S that rely on govts and banks not expropriating

Trust and economic performance (I) In higher­trust societies, less is spent in protection from economic transactions Written contracts less likely to be needed Litigations are less frequent Less dependent on formal institutions Trust can *substitute* (Incomplete!) PR or contract enforcement Informal credit markets depend on strong interpersonal trust Government more trusted (Trust that they won’t raise interest) People adopt more appropriate horizons when investing (Long Run > Short run)

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→ When there is low trust entrepreneurs devote more time to monitoring (less to innovate)

Trust and Human Capital Access to credit for the poor → Higher enrollment in education Linked to better performance of governmental institutions Returns to specialized education ↑ If low trust, positions are occupied based on blood / connections

Lowers the returns on education

South vs North Italy: (Putnam, 1993): Public services more effective than in the less­trusting south.

In south contracts express more personal concerns, while in the north they involve welfare of the region as a whole

Survey measures of trust ­ World Values Survey“Generally speaking, would you say that most people can be trusted, or that you can’t be too careful in dealing with people?”Empirical Evidence on trust and growth and trust and investment:

TRUST → Growth↑ Investments ↑ Output↑ Capital ↑ Schooling ↑ Knack and Jeefer, 1997 BUT: Causality? (More income may lead to more trust)

Trust can change dominant strategy from inefficient Nash Equilibrium to Pareto­efficient Equilibrium!

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