1.00

Economic Development: A Global Challenge

The World consists of over 200 countries, a patchwork of different

cultures, religions, legal systems and economies. Despite these

differences most policy makers have a common objective: to improve

the living standards of their citizens.

"I guess what we mean by economic development is a situation where

people are really able to fulfill their true potential, without

having lives shortened by ill health ot by living in severe

poverty ' Dr. Anthony Venables LSE

"Economic Development can also be defined by the standard of

living: how rich are poeple, not only in monetary terms but in all

aspects of their lives " Dr. Timothy Leunig LSE

In this film we wil look at the dynamics of economic development:

what makes it happen? And why do so many countries lag so far

behind

3:00

Measuring Economic Development

It's important to ask what we mean by high living standards and

how we measure a societies economic development. Most people agree

that a high living standard includes long life expectancy,, no

poverty , low child mortality, access to clean drinking water,

basic healthcare and education.

It is useful to have an single indicator to help assess the degree

of economic development in a country . GDP is such a measure.

This map shows GDP per capita for the year 200o at PPP (purchasing

power parity) which takes into account differences in the living

costs in the different countries. For this reason few countries

are shown with a per capital income of less than a dollar a day.

" A better meausure might be the HDI (Human Development Index) ,

used by the UN, and that not only includes income per head, but

also measures of longevity, and measured of education" Dr.

Timothy Leunig LSE

There are huge variation in income across countries in the world

today and they refelct different levels of economic development.

The range of development is so huge that 80% of world income is

earned by 10% of population of its population, while the remaining

90% of world population currently generates only 20% of world

income. So the standard of living of America, with a per capita

income of $40.000 is world apart from for example Ethiopia with a

per capita income of $800. Indeed some estimates suggests that

almost half of the worlds population lives of less than a dollar a

day. What could possibly explain these differences, and how could

these inequalities be reduced?

5:30

Determinants of Income and Growth

When discussing economic development. it is important to

distinguish between the level of per capita income today and the

growth rate of per capita income over time. For example in 2003,

some of the countries with the highest income levels in the world

were Norway, Canada, the U.S, and Switzerland. BUt the highest

growing countries, mostly included low-income countries, such as

Angola, Chad, China and Mongolia. There is nothing that prevents

poor countries from growing faster than rich coutnries. In fact,

there are many reasons why we would expect this to take place.

Income levels and growth rates vary across time and across

countries. To understand these patterns we need to know what

determines income and growth levels.

The answer is surprisingly simple: Productivity, or the number of

goods and services produced by each worker per hour. Since all

goods and service generate income when they are sold, higher

productivity translates in higher per capita income. If an

American worker is more productive than a worker in Bangladesh,

then the living standards, as measured by input per capita should

be higher in America. Likewise, high growth in productivity

translates into high growth rate of income. The productivity of a

Taiwanese worker has increased more than that of an American

worker over the last few decades, and hence Taiwan has experiences

higher growth than the US. But what the determines productivity?

"In the short run the 3 majot determinants of productivity are:

the skills of the people, the number of machines that they have,

and the quality of those machines, which is another way of saying

technology"Dr. Timothy Leunig LSE

Physical Capital

Physical Capital Refers to structures and equipment used in

production. The more equipment each worker has, the easier it is

for him or her to produce more output per hour. One important

charactertics of capital is that it's produced. so a country can ,

in effect, choose how much it wants to increase its capital stock

each year. The increase in the capital stock is what generally

called investment. The level of investment is related to the

savings rate of a country, which tells us how much of total income

is allocated consumption and how much is saved, and hence

available for the production of capital. A higer savings rate

increases productivity and thus income, but does not permantly

increase the growth rate.

" East Asian Countries built up their manufacturing industries

mainly of the basis of very high domestic savings. In China for

example the savings rate is about 40% of GDP, so there are

enormous domestic savings going into investment.

It is still to some extent a consensus among policy makers that a

country can achieve higher economic growth and increase its living

standard more rapidly by increasing investment. But capital is

likely to exhibit diminishing returns. meaning the first machine

provided to a worker makes him or her much more productive but

with each additional machine provided the worker's additional

output declines. If the return to capital diminishes the growth of

income will at first increase but then subside as the increased in

productivity level off. Due to the diminishing returns of capital

an increase in the capital stock leads to greater improvement in

productivity when the initial stick is low then when it is high.

This suggests that poor countries should grow faster than rich

countries and would explain why countries such as south Korea have

grown faster than the US. Although the percentage of income going

to investment has been approximately the same over the past 40

years.

Human Capital

Human Capital refers to the stock of knowledge embodied in a

person due to education, training and experience. Highly skilled

labor produce more per hour than low skilled ones. This is an

important reason why developed countries exhibit higher

productivity and higher living standards.

"Human Capital makes people more productive than people would

otherwise be. They would be able to operate different machines

because they can read and write" Dr. Wilhelmus Spanjers, Kingston

University.

Developing countries on the other hand have trouble providing

education to all their citizens and suffer from a low stock of

human capital.

In addition, migration from skilled workers from developing

countries to developed countries, the so-called brain drain, tends

to further reduce human capital in poor countries.

However, just like physical capital, human capital is likeley to

exhbit diminishing returns, so increases in human capital are

unlikely to permanently raise the growht rate of income, but will

definitely increase the overall income level and hence the

standard of living.

Technology,

Finally the most important engine of sustained growth is

technology. Technology is broadly defined as "the bleuprint of the

prodcution process". The better the technology, the more output

is produced, so technological innovation leads to higher

productivity. An explostion of technological advances occured

during the industrial revolution. Innovation, such as the steam

engine, electricity and external combustion machines, all made

workers more productive and spurred a high growth rate. Unlike

physical and human capital technoligy does not exhibit diminishing

returns. Economist today agree that the most important determinant

of economic growth and development is technological innovation.

But the diffusion of tecnology from rich to poor countries is

slow. This lack of technology sharing could potentially explain

the some of the persist growth differentials across countries.

"The main way in which developing countries can succeed in

development is to start with the right sectors. There is no point

whatsoever in aiming for high tech goods. You need to start with

those things that you can do best, which is almost always

textiles. SO we can see that China started off with textiles, it's

now moved on to basic engineering such as microwaves"

13:00

Causes of underdevelopment

Given what we know about what factors determine economic

development and growth, why are some nations stuck at low levels

of development?

No one argument can yet explain underdevelopment, but it's helpful

to examine some differences between rich and poor countries.

Geography

Some countries' geography helps their development. For many

countries, their physical environment provides natural resources,

such as oil and minerals and fertile land for agriculture. Other

countries experience harsh seasons, repeated natural disasters or

barren landscapes from which they must generate food and shelter,

let alone income. An additional geographic characteristic considered

key to development is proximity to a large economic center. Many

of the largest growing asain countries rely on Japan for FDI as

well as a key market. Whereas landlocked or isolated countries

tend to experience less development

" Developing countries may not be able to serve a big market" and

therefore they may have to focus on small-scale production. In

this case they may not be as efficient as industrialized

countries, and this may hamper their development" r. Wilhelmus

Spanjers, Kingston University.

"Africa suffers a unique disadvantage that more places in Africa

are far from the coast and not surprisingly Africa is less

developed than anywhere else in the world "Dr. Timothy Leunig LSE

Geography also affects ED because it influences the social and

political framework within which governments try to develop. Some

countries receive foreign development assistance because of their

political or strategic importance for the major powers. While

other cannot focus their economic resources on economic

development beacuse their physical location leaves them exposed to

their neighbours wars or refugees.

History

The past influences the present and it is clear that most of the

less developed countries were once colonies.

So some scholars have argued that the history of colonialism

scarred regions or entire regions in ways that prevent healthy

economic development. They point to the negative consequences og

colonial practices, such as the extraction of precious resources,

including labor as slaves, the reorganization of agricultural

production. the forced creation of new countries and the

imposition of political structures in congress to the local

culture. In some cases this institutional underdevelopment can be

traced back to a colonial experience.

In many other however the underdevelopment is better explained by

more recent political or economic dislocation suchs as leaders

pursuing war or self-enrichment at the expense of the general

populations welfare. Angola is an example of a country still

recovering from its colonial past. It was both in the grip of an

anticolonial war and a civil war when its colonial master,

portugal , hastily granted its independence in 1975. Rather than

supervising elections Portugla abandoned the country without

formally handing over control to a succeeding government.

Unprepared for nationhood and beset by violent factions and in

extreme poverty Angola became a battleground for international

cold war rivalries. The country rarely had peace until the death of

a rebel leader in 2002. But as in many former colonies its open

to debate what’s the cause of Angolan poverty today. Is it history

or bad governance since independence that has squandered the

countrie’s vast mineral wealth.

Some scholars today conclude that the capitalist system today

creates a neo-colonial system of a northern core and southern

periphery. They hold that because economic benefits accrue to the

most productive the states predominantly in the northern

hemisphere tend to get richer while those in the southern

hemisphere do not.

While this broad argument makes sense there are far to many

exceptions: many high growth countries were once colonies,

including Korea Taiwan and India, as were many high income

countries.

"Some countries that were once colonies have done remarkably well,

the United Stated is an obvious example, Canada and Austriala are

other examples. It isn’t the case that having been a colony

Necessarily means you cannot make the transition/"Dr. Timothy

Leunig LSE

Conversely not all poor countries were once colonies. As a result,

while colonialism undoubtedly influenced the development path of

many countries, like geography it offers only a partial

explanation of the persistence of underdevelopment. What scholars

recognize form history is that in many less developed countries,

state and market institutions, such as a fair judiciary, well

established property right and legal credit institutions are not

yet functioning well.

"But then you look at a country like China fastest growing economy

in the world that doesnt have proper democracy just yet"

For some, violence, political instability, or sheer corruption has

prevented the establishment og the lgal and institutional

infrastructure, which must be in place before real economic

progress can occur. This has been the case with Haiti, one of the

least developed countries in the Western Hemisphere and one of the

poorest in the world. Haiti's economic stagnation is largely the

result of political instability. It continues to suffer the

consequences of a coup in 1991 and domestic and foreign investment

has been slow to return

20.00

While there are concerns about the earths ability to provide for

an ever-growing population, the more pressing issue regarding ED is

the distribution population increases. Poor countries tend to

have much higher population growth rates than rich countries, so

one of the solutions is increased ED in poorer countries Today in

much of the advanced world, populations are growing only through

immigration, their birth rates are at or below replacement rate.

As a result Appr. 90% of population growth takes place in poor

developing countries. How does this impact development. First it

means that an increasing proportion of the world children are

being born into environments in which their families and their

government have fewer resources with which to provide for their

need. In Economic terms, a large proportion in individuals,

coupled with the low quality of their education system is

detrimental to the stock of human capital, and child labor is

likely to become commonplace.

What is the negative Malthusian view? Rapid population growth

presses upon resources, leading to environmentla degradation,

generating political instability, and being an inhibitor to

growth.

22.00

One of the most striking differences between developed and

developig countries is the distribution of income. Poor coutnries

tend to exhibit greater inequality than rich countries. For

instance the richest 5th of the population receive over 60% of

income, while the poorest 5th receives less that 4%.

What cause income inequality?

Kuznet was the first to analyze the relationship between income

and inequality. He found that poor countries displayed greater

income inequality than rich countries. But he also found evidence

that extremely poor countries had a more equal distribution than

less poor countries. So he concluded that income inequalities

increases at the early stages of development but falls at the

later stages of development.

The Kuznet Curve shows and upside down U-shaped realtionship

between income and income inequality. This probably due to the

fact that an economy does not grow equally across sectors. The

manufacturing sectr might grow faster than the agricultural sector

. The benefits of this growth go primarily to the workers in the

manufacturing sector, and hence income inequality increases. But

since manufacturing goods increase all goods in the economy, the

demand for agricultural products eventually rises, and farmers

income increases, as a result income inequality falls in the later

stages of development.

Some of the most unequal societies in the world are to be found in

Latin America. Brazil is the most unequal in the world.

Income inequality can also affect future economic development if

it reduces the average savings rate and if it leads to demands

for more equitable distrubution. If a countries displays a great

deal of large wealth and income inequality, policy makers may be

pressured to redistribute wealth and income through taxation or

other measures or trhogh a one-off distrubution of wealth like

land-reform. The problem with taxation is that it distorts the

incentive to save and thus has a detrimtal effect on growth. The

problem with land reform, is that it requires gret political

determination.

26.00

Production Structure and the Dual Economy

Another striking difference between poor and rich countries is the

size of the rural sector. In poor countries most of the population

lives in the countries side, while in rich countries most of the

population lives in the cities. According to the World Bank more

than 30% of output in low income countries comes from Agriculture.

This figure is only 1-7% in rich countries. While 72 % of the

labor force lives in a rural setting and only 20% in rich

countries. The physical and human capital stock machinery

fertilizers and crop management in the agricultural sector

indeveloping countries is typically very low and results in low

productivity. And because of large variability in conditions and

in world prices for staple food, agriculture is inherently risky.

Since farmers in developing countries have no other income sources

, and are living close to the subsistence level, income shocks can

be devastating. Dependant on a few vulnerable crops, and reliant

on imported oil, Ethiopia lacks sufficient foreign exchange

earnings. Agriculture makes up more that 80% of its exports, and

employs more than 85% of its population. The country has to

diversify its economy, if it isever going to escape its reliance

on foreign aid.

As the country makes the transition form agriculture to an

industrialized economy, the so-called 'dual economy' phenomenon

may arise. Since industrialization typically occurs in the urban

areas, two economies emerge within the coutnry. The rural economy

remains at the old level of development, while the urban economy

exhibits the modernizations found in more developed

coutnries.Higer wages and better labor conditions encourages

workers to move into urban areas, away from the impoverished

conditions in the rural sector. This migration has to occur when a

country industrializes

?? In the short run it can have a terrible effect when people leav

the farms and move to the towns there may not be jobs to

accomodate them.

But many poor countries experience excessove labor flows, causing

high unemployment and urban poverty. Higer urban wages and greater

job security are not only due to greater productivity and

manufacturing, but also arise because of labor unions, and because

employers are willing to pay higher wages in order to attract good

quality workers. Because of these wages labor supply exceeds the

demand for labor. So many people flowing into the cities find

themselves either unemployment or working in the service sector

where the wages are more flexible. Indeed the two most striking

characteristics of large cities in developing countries are high

unemployment and a large service sector feuturing domestic help,

shoe shining and street venders. Rapid industrialization also

results in the growth of the informal sector, meaning insecure

jobs, jobs which are badly paid, jobs where people have few social

rights.

30.00

Credit markets

A final obvious difference between rich and poor countries is that

less developed countries usually lack a well-functioning financial

system and domestic credit market. The purpose of the financial

system is to Channel funds from savers to borrowers with

productive investment opportunities. The problem facing credit

market in both rich and poor countries is that of assymetric

information, where the borrower has more information about the use

of the funds than the lender. Since the lender cannot distringuish

between good and bad credit risk they may not provide any funds at

all. YOu would typically want to have either very clear control

and knowledge about what they're doing with your money, or you

want to make sure that if they mess up you have another way of

getting your money back. Solutions include establishing property

rights and implementing a legal system forcing borrowers to repay

debts. But the legal systems of poor countries tend not to

protect property rights or reinforce payments of debt very well.

So formal credit markets in less developed countries are often

almost non-existent. Recently there have been some sucessful

attempts by non-profit organisations to provide credit to the very

poor in the developing countries, so-called micro-credit

institutions. Obviously very poor borrowers can't provide

collateral, so the banks lends very small amounts to groups of

borrowers on the condition that if anyone in the group defaults

onthe debt, none of the group can seek loans again. The most

famous example of sucha bank is the Grameen Bank, in Bangladesh,

which lends money mostly to women and claims a 98% repayment rate.

By 2004, it had 3.7 million borrowers.

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Conclusion

As we have seen a number of factors affect economic development.

Under Ideal circumstances investments in physical capital, human

capital and technology, combine to produce growing incomes. Yet

circumstances are not always ideal. Geography, history,

underdeveloped state and market institutions, population growth,

inequality, dual economies and inadequate credit markets

contribute to the persistance of widespread poverty in the world.

Goverment policies can significantly change the prospects for

development, as successes in East Asia have shown.

But there is still much that we do not know about the forces that

make countries fail or succeed, although we are much more

knowledgeable than we were 50 years ago, there is much work left

to do.