APEC 460/660 Spring
2006 Kilkenny
Week 8 HOMEWORK “#4”
Re: Appendix
2.1 and chapter 3 of T&S on “classic
theories” of economic development:
i.
‘Stages of Growth’ e.g., by Rostow
ii.
Harrod-Domar
iii. Structural change (e.g., Lewis, Chenery)
iv. neo-colonialist dependence (e.g., Dos Santos)
v.
false-paradigm
vi.
dualistic
development
vii. neoclassical counterrevolution (e.g. Bhagwati)
a. free-market analysis
b. public choice theory
c. market-friendly
viii.
Solow neoclassical
growth
Rostow ‘stages of growth’ model (1960)
The question: “What pattern of transition from un-developed to developed do countries have in common over time?”
Katherien has an older
edition of T&S that lists the stages:
1.
traditional society
2.
preconditions stage
3.
take-off stage
4.
drive to maturity
5.
high mass consumption
Graphically:
Who: not
explicit in T&S textbook; implicitly it is everyone in a country; no-one in
particular.
Objectives:
Implicit: Maximize output per person.
Instruments: Implicit:
choose a rate of saving.
Constraints: none are explicit in our textbook. Implicitly, as we know,
production can either be consumed or saved (and thus invested). This is the key constraint.
Time horizon: very long run, because capital and technology are changing
over time.
Insights: The constraint
carries the main lesson of this ‘model.’ It is a fact that saving
and investing are decisions that must be made consciously. It entails a trade-off: save today means
enjoy less consumption today. But
societies who consume everything now cannot grow later. Rostow’s
“stages” analysis of nations that have developed suggests that if
undeveloped societies would also make the less easy choices to save and invest,
that they too will grow. It
is a story that gives hope. Otherwise….
Microfoundations:
weak (as far as we can tell from the textbook).
Practical
implications: the insight that to be able to grow,
investment is needed, which depends on saving.
Harrod-Domar Growth Model (1950s)
The question: “What is the relationship between the rate of saving
(s = S/Y) and
growth (∆Y) ?”
Who: not
explicit in T&S textbook, implicitly it is everyone in a country or no-one
in particular.
Objectives: Implicit: maximize the rate of growth: ∆Y/Y.
Instruments: Implicit: choose
a rate of saving.
Constraints: notation: Y is GDP, S
is savings, K is capital stock, I is investment, s = S/Y; k = K/Y:
1.
rate of growth in GDP
depends on the relative rate of savings : ∆Y/Y = s/k
a.
(by definition) S = sY (the amount
saved is some fraction of total output)
b.
(by definition) I = ∆K (investment is the change in capital
stock)
c.
(by definition) k = K/Y
(k denotes the capital:output ratio)
and ∆K/∆Y
= k. Rearrange this identity to get
∆K = k∆Y.
d.
(by
definitions b. and c.) I = ∆K=k∆Y
e.
by definition S = I (investment is constrained by available
savings)
f.
by a., e., and c:
S = sY = I = k∆Y à sY = k∆Y rearrange à ∆Y/Y = s/k
(the constraint.)
Time horizon: long run: the level of fixed capital is changing.
Insights: As in Rostow’s work, the constraint on growth posed by a
country’s ability to save/invest is the lesson of this model. Implicitly, if a country does not
produce enough to be able to save, as is the case in most LDCs, it has to find
some other way to finance investment.
This model implies that the only other ways are to borrow or get aid
from other countries.
Microfoundations:
weak. The model provides no clue as
to why anyone in an LDC could or would want to save for the future, or how to
motivate householders (capitalists or workers) to consume less now and save
more for later. Nor does it provide
insight into why other countries might be willing to donate or lend to a
developing country.
T&S
assessment: T&S say that this model
motivated developed countries to provide development aid to underdeveloped
countries. That was a nice
consequence, yes? T&S
also say that while the model highlights one necessary condition (S=I=∆K), it did not identify sufficient conditions for growth. That is, just having money or making an
investment is not enough, is not sufficient to sustain
growth. There are so many more
things that have to be taken care of for investments to lead to growth, such
as:
“structural, institutional, and
attitudinal conditions (e.g. well-integrated commodity and money markets,
highly developed transport facilities, a well-trained and educated workforce,
the motivation to succeed, an efficient government bureaucracy)… T&S
page 108.
Lewis’ Two-Sector model of
structural change (1954)
The question: How can an LDC economy with surplus labor in peasant
agriculture finance its own investment, structural transformation, and growth?
Who: (i) Industrial firms, (ii) subsistence farmers
Objectives: (i) profit, (ii) utility or welfare (implicit)
Instruments: (i) how many employees (ii) where to work: rural subsistence
farming or urban industry
Constraints: constant urban real wage rates; unchanging technology,
formalized by exogenous Marginal physical Products of Labor
in Agriculture and Modern industry that are decreasing: MPL,A; MPL,M,; the rate of growth in capital
stock: K(t) ; implicitly, all market prices are constant (increased supplies of
modern goods has no affect on the price paid for modern goods); and decreased
subsistence farming has no effect on the marginal value product of labor in
farming.
Time horizon: long run: capital is growing and labor migrates; but
technology does not change.
Insights: If
industrialists reinvest all of the return to production that is not paid to
workers, this will expand the capital stock, labor productivity in industry
will rise, the firms can afford to hire more workers, there will be structural
change as the workforce will shift out of farming and into industry, more
profits will be made, and so on.
A very useful lesson is that
growth can be financed by retained earnings.
Microfoundations:
Why would owners of firms re-invest all their profits? There must not be any land rent to pay,
no interest on credit, etc…
Why aren’t local prices sensitive to local supply or demand? Why, if farmers get their average
product, doesn’t the average product rise as the total number of farmers
(across which the maximum yields are being shared) falls?
T&S
assessment: T&S say that this model
‘roughly reflects the historical experience of economic growth in the
West’ (page 111) but they criticize the assumptions that all profits
would be re-invested, growth would be factor-neutral, surplus labor in the
subsistence ag sector, unchanging urban wage rates,
and decreasing returns with respect to the level of employment in the modern
sector.
neo-colonialist
dependence
The question: why are some nations so rich and others so poor?
|
who |
small elite ruling class |
foreign special interest power
groups (“center”) |
everyone else in the “periphery.” |
|
objective |
utility |
profit |
survival |
|
instrument |
secure their role/payoff in the int’l
division of labor determined by the center |
maintain and exploit the monopoly/monopsony
power they stole |
Revolt, State-own all industry |
|
constraints |
the initial distribution of wealth |
||
Time horizon: long run.
Insights: underdevelopment is a consequence
(not a stage in a growth process) of an international division of labor and exploitation
by foreign countries that is facilitated by local lackies.
Practical Implications: This paradigm is considered Marxist, and has in fact inspired revolutions. Thus, it has had very big effects on our
world. But as a model for how to
develop a country, it is useless, because it is not really Marxist
enough. It ignores Marx’s insight/caution
that (basically) power corrupts. ‘Burning
the rich’ will not solve a country’s problems,
it just changes who is rich and who is corruptible. We still have to look elsewhere to answer
the basic questions: how to disperse power, undermine anyone’s ability to
exploit market power, and how to diminish the payoffs to corruption, without
thwarting the profit incentive/payoffs that inspire innovation, investment, and
growth.
false-paradigm
The question:
|
who |
Developed country “experts” |
Local elites |
Local leaders and intellectuals |
|
objective |
Not explicit |
profit |
Not explicit; implicit objective is to
lead their country to grow |
|
instrument |
Advise LDC governments and teach
LDC leaders and intellectuals |
maintain and exploit the monopoly/monopsony
power |
measure things, attempt to raise savings
& investment, privatize;
deregulate, pursue other irrelevant policies |
|
constraints |
Ethnocentricity & ignorance |
Traditional institutional social
structures; Highly unequal property
ownership, disproportionate power of local elites, unequal access to credit |
What they’ve been taught by
the developed country experts |
Insights: One size does
not fit all.
Microfoundations:
weak.
Practical
Implications: Think for yourself. If you study from someone else, learn HOW to think, not WHAT to think.
dualistic development
T&S
explanation parallels the neocolonialist model (above). The main insight is that the world
economy is like a zero-sum game; the poor are made poor by the rich, who
basically get rich by stealing.
Again, this is not a model that provides any ideas how to become rich,
except—implicitly-- by doing
what the rich are supposed to have done—by stealing.
T&S assessment of the above three models: “offer little formal or informal explanation of how
countries initiate and sustain development. Second and perhaps more important,
the actual economic experience of LDCs that have pursued revolutionary
campaigns of industrial nationalization and state-run production has been
mostly negative.” (page 119)
neoclassical counterrevolution (e.g. Bhagwati)
The question: What level of public (state
or government) activity best promotes development?
|
who |
LDC governments |
||
|
objective |
Economic development |
||
|
instruments |
What they are doing (‘mistakes’) |
What they should do (‘advice’) |
|
|
free-market analysis |
Control prices, run industry,
prohibit trade |
Laissez-faire; trust
markets to allocate resources; promote competition |
|
|
public choice theory |
Government officials are
corruptible |
Reduce government as much as
possible |
|
|
market-friendly |
Ignoring the sources of market
failures with respect to information, Coordination, environmental
externalities, and returns to scale; |
Recognize the causes of market
failures; invest in physical and social infrastructure, health care,
educational facilities, promote competition and
private enterprise, capture scale economies… |
|
|
constraints |
|
|
|
Insights: Like Marx, this
school of thought recognizes that power corrupts. So it suggests that countries reduce the
number of persons in authority and disperse power by promoting competition and
widespread enfranchisement and ownership.
Microfoundations:
not explicit in T&S (but they are very well-developed, as we can see later)
T&S assessment: this school of thought is the foundation of modern theories
of development
Practical Implications: To develop your
country, if you aren’t already corrupted, figure out how to ‘ride the
horse in the direction it is running.’ That means, find ways to placate/satisfy
the power elite and inspire them so that the things they do to enrich
themselves are the things that employ people, provide valued goods and services
(especially education and R&D), protect the environment, etc.
Solow neoclassical growth model (1956;
Appendix 3.1)
The
question? “What is the relationship
between investment and growth? At
what rate of saving (investment) can this economy be sustainable (achieve a steady
state)?”
Who: In a
country, this models (implicitly) focuses on people as:
1.
producers
2.
capital owners
3.
labor owners
(‘workers”)
Objectives? Not explicit: Maximize output?
Instruments: choose
a rate of saving. Note: maybe the
single most relevant ‘who’ is capital owners—who
save/invest? No, the model is
described in terms of “savings per worker”.
Constraints: (exogenous variables)
1.
production technology:
output at time t Y(t) = K(t)α[A(t)L(t)]1-α
is
made from capital K(t) and labor L(t)
2.
A(t) ~ labor
productivity ~ grows over time at constant rate, γ (and let γ=1/L)
3.
labor force grows at
the rate n
4.
capital depreciates at
rate δ
5.
savings per worker, at
rate s, is positively related with
output per worker (y=f(k)),
so s(t)/L(t) = s·f(k); but
the savings rate increases at a decreasing rate as the economy grows (shown graphically in Figure A3.1)
6.
in equilibrium ∆k = 0 = s·f(k) – (δ+n·)k
Time horizon: very long run, because endowments of labor, levels of
capital, and technology are all changing
What does the
model tell us? The equilibrium condition says that if s·f(k) >(δ+n·)k,
then more capital will accumulate and the economy will grow. Conversely, if s·f(k) <(δ+n·)k then there will be less saving and
investment, and the economy will shrink.
The modelers claim that this story identifies a k* which “is just right.”
It does not tell
us why workers or capital owners (or whoever) might decide to save more (or
save less). (I wouldn’t want
to save more (& invest more, which means build up productive capacity) unless I
expected a higher return on my investment, which would mean, I expect everyone
else to CONSUME MORE and save less.
But to achieve more investment in our economy everyone has to save more. But how can everyone save more if
everyone is saving less? Or, who
would save more, on net, while others save less? And why might some do one thing, others
do another? How do we encourage
more net saving (or discourage excessive saving?) This model has weak microfoundations. Nor
does it address the fact that a foreign capital inflow (capital account
surplus) only arises when a country is sustaining a current account deficit
(imports exceeding exports). That is a logical contradiction with claim that countries
must trade to be able to enjoy increasing returns to scale in domestic production
and be net exporters.
Practical
implications: to get a backwards economy
out of the subsistence farming stage, this model says we have to find k*. T&S report that is also implies that
open economies (who can exploit scale economies) are more likely to attract
more foreign savings and can grow faster.
This model does not imply that the government should, for example,
collect taxes and invest in education, roads, infrastructure, research, or
anything like that. Indeed, if
there are taxes, then there is less saving. It has nothing to say about minimum wage
laws. It has nothing to say about
why inequality seems to be related to growth. It has nothing to say about
anti-trust regulation. It says
nothing about the role of a country’s legal system….