Why is Economic Development so Difficult?

[2 – June 12 2003]

Review Many conceptions of human development

– Roosevelt: four freedoms– Sen: sustenance, self-esteem, freedom– Stiglitz: transformation of society– HDI: life expectancy, literacy,

enrollment, GDP per capita (PPP$) Economic Growth correlates with human

development, and in particular Growth helps the poor

– 1% in overall GDP per capita = 1% in GDP per capita for poorest 20%

Great Structural Diversity among Developing Economies Size and income

level Historical

background Physical and human

resources Ethnic and religious

composition

Relative importance of public and private sectors

Industrial structure External dependence Political structure,

power, and interest groups

But, they face Common Challenges: Extremely Low per capita GDP Low or negative GDP growth over time Growing disparity between richest and

poorest countries

Sructural Challenges:

High dependence on agriculture and primary product exports

Rapid rural-urban migration Low levels of productivity High rates of population growth and

dependency burdens

0%

20%

40%

60%

80%

100%

Africa Asia U.S.

agriculture industry services / other

Basic Structure of Economies: Africa vs. Asia vs. U.S.:

Deeper Economic Challenges

Macroeconomic: – High inflation– Black markets for foreign

exchange– Trade barriers imposed by rich

countries– External debt (?)

Deeper Economic Challenges

Microeconomic: imperfect or missing markets– Markets for borrowing, saving,

and investing (credit and financial markets)

– Markets for spreading risk (insurance markets)

Deeper Economic Challenges: Imperfect Information Markets work well when buyers and

sellers have good information Markets fail or don’t exist when buyers

or sellers (or both) have poor information

Poor information is not the same as “little information” (recall our auction)

Markets can work poorly when buyers have information but sellers do not, or vice versa – asymmetric information

Imperfect Information: Example

Lenders do not know if farmer is good credit risk……

Farmers have no collateral (the developed countries solution to this problem)

Hence, farmer cannot get loan to buy land, Hence, farmer must somehow rent the

land….perhaps by sharecropping Which does not give farmer full marginal

benefit of his labor – “inefficient”

Without Credit and Insurance:

People live “on the economic edge” A small shock can mean ruin:

– Illness can’t work, no income– [no unemployment, no insurance]– Sell assets for medicine, food– [What assets???]– Future productivity drops

Social Challenges: Missing Institutions

A market economy needs:– Security, peace– Justice system to enforce contracts– Financial system:

• To collect funds from savers• Allocate credit to borrowers• Stable currency

– Transaction information (what am I buying?)

– Effective, fair, government

What about Science and Technology?

We will see that technological progress is the only real source of long-run growth

Technology is already here….. Why can’t LDCs take advantage of past

(and current) discoveries?

Sachs’ “Quadruple Bind”

1) Innovation responds to demand. Demand comes from rich countries

2) Innovation requires critical mass of science. Poor countries have no critical mass

3) Existing knowledge applies to temperate zones

4) climate change limits world growth (shakier argument)

Looking Ahead: The Quest for Growth

(in per capita GDP) Does Aid for Investment for Machines cause growth?

Does Education for Skills cause growth? (Does controlling population cause growth?) Does reducing debt cause growth? What is a poverty trap? How can people escape from poverty traps? How can policy and institutions be improved

to help people escape from poverty traps?