Chapter 1: Introduction to Economic Development

Development Economist

Adam Smith (1776)- "Wealth of Nations" First economic book First ever development economist "Father of Economics" Adam Smith= moral philosopher 1st economist to write tangible material on the "laissez-faire" concepts that physiocrats had been discussing for years laissez-faire = free market

W. Arthur Lewis and Theodore Schultz Instead of discussing the nature of an economy they saught to see the mechanisms to influence an economyBoth talked about how to restructure an economy by making one sector profitableDuring the 19th century, the chosen sector was predominately the agrarian sector In this sector, there will be "useless labor" or excesses supply of labor that is not used in the agrarian sector.Hence that labor will go to the manufacturing sector where goods will be made.Since the manufacturing sector is "inherently" a capitalist sector (profit max.) then profits will be madeThose profits will be re-invested to the sector and growth occurs

Traditional Economics

Goal: Efficient resource allocation with optimal growth of these resources for future growth and production Characteristics of a Traditional Neoclassical Economy

Perfect markets, automatic price adjustment, utility maximizes, private profit and equilibrium outcomes in product and resource markets Economics "rationality" (axiom: more is better/utility max.) of self-interested individuals No market failure, no intervention, "The invisible hand" -> Price is determined by demand/supply

Definition of Utility: the satisfaction of consuming a unit of a good or servicesEfficient resource allocation- distribution such that demand is equal to supply (D=S) in every market

Definition of Political Economy: Is a relationship between politics and economics with an emphasis on the role of power in economic decision-making.

Development Economics

Scope of development economics is greater than that of the traditional economyMust take into consideration the overall social system of a country Definition of Social systems: the organizational and institutional structure of a society, including its values, attitudes, power structure and traditions

Efficient allocation of scarce resources and their growth (traditional economics) as well as economic, social, political and institutional mechanisms- both public and private

Economic cultural and political requirements for effecting rapid structural and institutional transformation that will efficiently allocate the outcome of economic progress to the highest possible percentage of the population- the role of the government Focus on mechanisms that keep families, regions and nations in poverty traps and on the effective strategies for breaking out of these trapsIncludes a larger role of the government and a degree of coordinated decision making Combines theories from traditional economics analysis and new models along with case studies

there are no "blanket" policies that apply to all nationsespecially in the developing world where differences amongst developing nations are much more stark than in developed nations

What's Development?

Economic terms Development is: achieving sustained rate of growth of income per capita to enable a nation to expand its output at a rate faster than the growth rate of its population.

Levels and rates of growth of real per capita gross national income (GNI) are then used to measure the overall economic well-being of a population

GDPGross Domestic ProductMeasurements: Expenditure, Income, or Product Condition: All values of measurements must equal to each other

Traditional Economic MeasuresThe capacity of a national economy to generate and sustain an annual increase in GNI (Gross National Income) at rates between 5%-7% or more. Alternatively, the rate of growth of per capita income.

The New Economic View of DevelopmentRedefined in terms of the reduction or elimination of poverty, inequality and unemployment within a growing economy.

Amartya Sen's Capabilities Approach

Definition of Capabilities: the freedoms that a person has in terms of the choice of functionings, given his personal features (conversion of characteristics into functionings) and his command over commodities""Economic growth cannot be sensibly treated as an end in itself. Development has to be more concerned with enhancing the lives we lead and the freedoms we enjoy"- Amartya Sen In simple terms, growth does not equal development rather that growth can lead to development Sen stressed the capability to function meaning: What matters is not the things a person has or the feelings these provide but what a person is, or can be, and does or can doDefinition of Functioning's- the various things a person may value doing or being. These may vary from those such as being adequately nourished to personal states such as being able to take part in the life of the communitySources of disparity (constraints) between real incomes and actual advantages

Personal heterogeneities- age, disabilities, genderEnvironmental diversities- clothing in cold, infectious disease, and impact of pollutionVariations in social climate- prevalence of crime and violenceDifferences in relational perspectives

Distribution within the family Gender often dictates (girls vs boys in terms of primary education) income distribution is more equitable when women are head of the household

Traditional Measures of Development

Gross National Income (GNI) Criticism: Per capita (an average figure) income doesn't represent the wealth gap in nations

Gross Domestic Product (GDP) Primary, secondary and finished products are included

GDP per capita (per head)

GDP vs. GNP

Definition of GDP: the money value of total amount of goods and services within the geographical boundary over a yearDefinition of GNI: the money value of total amount of goods and servces produced by the nationals over a period of a year.Using the core/periphery theory where:

the producer (core), consumer (periphery)Underdevelopment occurs b/c the core wants to grow but is dependent on the periphery to remain the same, hence producer makes more profits whilst the consumer is remained unchanged

Cause of povertySeveral factors including political bias, lack of willingness, work culture, etc. Population doesn't impede development but rather the production, allocation and efficiency of the population in the work force can be an impediment towards development.

Three Core Values of Development

These core values represent goals for both individuals and society as a whole

Sustenance- the ability to meet basic needs of food, shelter, health and protection Self-esteem- to be a person with a sense of worth and self respect. The nature may vary between societies and cultures Freedom from servitude (Freedom of choice)- to be able to choose. Wealth to gain greater control over nature. Freedom to choose greater leisure, to have or renounce goods and services

Development and Happiness

Amartya Sen "Utility in the sense of happiness may well be included in the list of some important functioning's relevant to a person's well-being" The average level of happiness or utility increases as a country's average income increases

This relationship is only seen from $10,000 to $20,000, since most individuals at this point have escaped extreme poverty

Financial security is an important determinant of happiness Richard Layard's Seven Determinants of Happiness

Family relationshipsPersonal freedom

Financial situationWorkCommunity and friendsHealthPersonal values

Bhutan has created a "Gross National Happiness" Index to measure their nations happinessTakes into consideration health, education, freedom, etc.

The Central Role of Women

Globally, women tend to be poorer than menWomen are primary child bearers

Studies show that women tend to spend a higher percentage of their income on their children than men do

Women also transmit values to the next generation

The Three Objectives of Development

(Linked to sustenance) To increase the availability and widen the distribution of basic life-sustaining goods

Example: food, shelter, health and protection (Linked to self-esteem) To raise levels of living

Example: higher incomes, provision of more jobs, better education, greater attention to cultural and human values.

(Linked to Freedom from servitude) To expand the range of economic and social choices available to individuals and nations by freeing them from dependence and servitude

Millennium Development Goals (MDG)

September 2000 at the United Nations Headquarters in New York 189 member countries adopted the 8 Millennium Development Goals (MDG) Human development goals to be reached by 2015 Goals

Eradicate extreme poverty and hungerImprove maternal healthCombat HIV/AIDS, malaria and other diseasesAchieve universal primary education Reduce child mortality Promote gender equality and women empowerment Ensure environmental sustainabilityDevelop a global partnership for development

Chapter 2: Comparative Economic Development

Facts and Figures

GDP per capita (PPP) is $47,200 in the U.S. and $1700 in BangladeshLife expectancy at birth is 78.37 in the U.S and 38.76 in AngolaLiteracy rate is 99% in U.K. and 47.9% in BangladeshExpenditure on health is 16.2% of GDP in the U.S. and 2.4% of GDP in India.

Source CIA factbook ; accurate as on January 1st, 2011

Questions

1. How have such great disparities persisted?1. With any sort of growth in an economy and with the saturation of economies, how is

that the gap is getting bigger rather than smaller? 2. How have some of these gaps widened?3. Why is it that some developing countries have made a great progress in closing these gaps

while others have made so little?

Features less developing nations have in common in comparison to developed nations

1. Lower levels of living and productivity 2. Lower levels of human capital 3. Higher levels of inequality and absolute poverty4. Higher population growth rates5. Greater social fractionalization 6. Larger rural populations but rapid rural-to-urban migration 7. Lower levels of industrialization and manufactured exports8. Adverse geography9. Underdeveloped financial and other markets

10. Lingering colonial impacts like poor institutions and varying degrees of external dependence (politically, economically, etc.)

Classification system of the World Bank

208 countries with a population greater than equal to 30,000 are ranked by their levels of GNI per capita.Low-income countries, lower-middle-income countries, upper-middle-income countries, high-income OECD countries, and other high-income countries.Developing countries are LICs, LMCs or UMCs.Low Income Countries - LICs GNI per capita (2005) less than equal to $875Lower Middle Income Countries- LMCs - GNI per capita (2005) between $876-$346 Upper Middle Income Countries- UMCs GNI per capita (2005) between $3466 - $10725Shortcomings/Limitations

High income countries w/ one or two highly developed export sectors, means significant parts of pop. are undedicated or in poor health for the country's income level. (Example: Saudi Arabia, UAE)Upper-income economies include tourism dependent islands with lingering development problems (Example: Portugal and Greece)

Other Bases of Classification of LDCs

A special distinction made among UMCs or newly high income economies, where some have achieved relatively advanced manufacturing sectors are called newly industrializing countries (NICs).Degree of international indebtedness - severely, moderately and less indebted (made by the World Bank)Level of human development (UNDP), least developed countries (LDCs)

Basic Indicators of Development

Real Income - Purchasing Power ParityConverting between currencies can use the PPP and exchange rates

Indicators of Health and EducationAll three indicators compose the measures of development

GNI- A Measure of Economic Well-Being

Definition of Gross National Income: calculated as the total domestic and foreign value added claimed by a countries residents without making dedications for depreciation (or wearing out) of the domestic capital stockGNI GNPGNI GNP = GDP + (income residents earn abroad) (payments made to non-residents who contribute to the domestic economy)GDP = The total value of all goods and services produced within the geographical boundary of an economy, over a period of one year.

Exchange Rates v/s PPP

In order to make GNI comparisons across countries, the local currency values of GNI must be converted to a common currency, usually the U.S.$, using,

Exchange ratesLiquidity: amount of currency in the domestic market Confidence: the value of the currency in the domestic markets

Definition of Purchasing Power Parity (PPP): The number of units of a foreign countrys currency required to purchase the identical quantity of goods and services in the local market as $1 would buy in the U.S.PPP is more stable to compare the changes in economies, exchange rates is far too volatile because of fixed exchange rates

Human Development Index

The annual series of Human Development Reports by the UNDP bases its analysis of the comparative status of the socioeconomic development on the HDI. The HDI bases on 3 goals of development.

Longevity: measured by life expectancy at birthKnowledge: measured by a weighted average of adult literacy and mean years of schoolingStandard of Living: measured by real per capita GDP adjusted for the differing PPP of every country s currency.

HDI Formula = 1/3 (income index) + 1/3 (life expectancy index) + 1/3 (education index)Measurement scale

From 0 to 1, 0 being the lowest human development and 1 being the highest human development

Definition of Human Capital: Productive investments in people, such as skills, vales and health resulting from expenditures on education, on-the-job training programs, and medical care Classification

Low human development: 0.0 to 0.499Medium Human Development: 0.5 to 0.799

High Human Development: 0.8 to 0.9 Very High Human Development: 0.90 to 1.0

Advantages of HDI

Reveals that a country can do much better than might be expected at a low level of income while substantial income levels might not attain very high levels of HDI.Disparities in income are greater than disparities in other indicators of development.Health and education act as components of human capital

Criticisms of HDI

Gross enrollment overstates the amount of schooling.Considers only those that enrolls, in many developing nations, many students drop out of school after enrollmentLiteracy does not mean education

Literacy is often determined by the ability to sign your own name, does not effectively test ones ability to read

There is no formal justification for allowing 1/3 weight to every component.There is no economic backing to support that each sector is worth 1/3 Income plays a more large role (>1/3) than the other indicators

Quality plays no role in the indicesSchools quality matters, not just the enrollment yearsQuality of life matter as well, being sick in bed for a year vs. being healthy and well-functioning

GNI used over GDPInt'l trade and globalization has put pressure to count the production of nations outside the country as well

Rural-urban differencesThe HDI value of a nation is not representative of the entire nationLevels of human development vary drastically depending on whether the are is urban or rural within a countryComparing the HDI within a city center (Shanghai) vs. a small village town (Western China)

The New Human Development Index (NHDI)

Introduced in November 2010, UNDP wanted to address criticisms of the HDIIndices

EducationHealthStandrad of Living

Changes from HDI to NHDIGNI per capita replaces GDP per capita Education Index chaged. Two new components added:

Average actual educational attainment of the whole populationHow educated the population are

Expected attainment of today's childrenAmbiguous: It is an idea rather than an actualityPrediction of the trend

Previous education index components: literacy and enrollment have been dropped

Maximum values in each dimension have been increased to the observed maximum The minimum value for income has been reduced. This is based on estimates for Zimbabwe in 2007The common logarithm (log) to reflect the diminishing marginal benefit of income, has been changed to natural logarithm (ln)

Other indexes are present as wellThe Inequality-Adjusted Human Development Index (IHDI): imposes a penalty on the HDI value that increases as inequality arose people becomes greater Gender Inequality Index (GII)Multidimensional Poverty Index (MPI)

Chapter 3: Classic Theories of Economic Growth and Development

Approach to Classical Theories of Economic Development

Purpose: trace down the initial kind of thought process that would bring about growth and development The Theories and patterns of structural change and international-dependence revolution inherently are against the linear stages of growth model

Linear stages-of-growth model1950s to 1960s Lays out the stages a country needs to go through to reach development Says you must have enough domestic capital and production (savings, investment and foreign aid) to reach developmentDevelopment was associated with rapid aggregate economic growth Rostows' Stages of Growth

Theories and patterns of structural change Replaced linear model in 1970s Lewis ModelCreate a sector in the economy that has the potential to help the economy mobilize domestic resourcesUsually this sector would be agricultural sector, each family would produce at a subsistence level, no surplus for profits therefore no savings, no capital accumulation and thus no growthJumping to a linear growth model is quiet difficult and complex The goal is not to have investment and growth alone but through creating a sector in which profits can be obtained through savings and investment

International-dependence revolution Also, replaced linear model in 1970sUnderdevelopment --> international and domestic power relationships, institutional and structural economic rigidities Developing economies are developing because of external pressureFalse paradigm model Savings mobilized within the economy is not the basic constraint that prevents growth and development within the economy, international, external pressure also

constrain the economy The neoclassical counterrevolution

Perfect competition, perfect markets, hands off government policy, free marketBuyers and sellers will look at the "invisible hand" = price, that decisions will be made so that all the goods are cleared and sellers generate exact amount of profit from sales This profit thus leads to saving, investment, capital accumulation ---> growth and development Solow model is a representation of this concept

Rostow's Stages of Growth

Made by economist, W.W. RostowTraditional society

Agro based economyFamily owned farmers, don't make profits Subsistence

Pre-conditions to take-offThere is a slit change from traditional society to producing enough

Take-offStart taking advantage of markets other than yourself (int'l trade)Produce surplusMobilizaiton of domestic and foreign saving in order to generate sufficient investment

Drive to maturity Total value of exports are enough to cover the total amount of imports

Age of high consumptionImports are such that you have a large range of consumables in your economy therefore you can offered to import what you do not have Consumption of goods has a wide variety and selection Pay for import with export earnings

Harrod-Domar

Definition: a functional economic relationship in which the growth rate of gross domestic product (g) depends directly on the national net savings rate (s) and inversely on the national capital output ratio (c)A basic example of economic growth

Also known as, the AK ModelBased on a linear production functionOutput given by capital stock, K, times a constant, often labeled A.

Background --> Keynesian economics, 1936Demand will create supply, such that each are exact --> market clearing price equilibriumTotal value of income = total value of output/production Created in the Great Depression

Low demand/consumptionExcess supply --> inventory for the producerSuppliers don't produce more, minimize inventoryTherefore, see if demand in market, must be supply (inventory)

If demand>inventory, produce more (underproducing) If demand< inventory, signal to stop producing (overproducing)

Concept also represented by, capital output ratioUnits of capital input (investment, capital, savings) = unit of output over a given period of time

Explanation of Harrod-Domar

Intuition

Since total capital stock, K bears a direct relationship to output Y, it follows that K / Y is the capital-output ratio. Define the incremental capital-output ratio as,

where, K / Y= c or, K = c Y

AssumptionsNet national savings must equal net national investment, S=I

Given the assumption that GDP methods are all equal, thereforeGDP Ex. Method= GDP Income MethodC+I+G+Xn=C+S+T+MI=S

Given:S = sY

Net savings= proportion (s) of total income (Y) I = K and

Addition to capital (K) is equal to investment (I)c= K/Y

Capital Output Ratio

ResultTherefore, S = sY= cY= K = I

Or, sY= cYDividing both sides by Y and then by k, we obtain

Y / Y = s / cBasically, rate of growth of income/GDP = proportion to save/capital-output ratio

Basic explanation: Harrod-Domar model states that the rate of growth of GDP is determined jointly by the net national savings ratio (s), and the national capital-output ratio (c) Furthermore, w/o gov't involvement, growth rate of national income = or > the savings ratio, visa versa w/ gov't Inversion of Capital-Output Ratio

Can be used to explain how savings and investment determines growth rateInverse of capital-output, 1/c --> output capital or output investment ratio

Other factors influencing growth rate other than investment; labor force growth and technological progress

Constraints and Obstacles of Harrod-Domar Increase growth by increasing savings proportionCapital Constraint: Constrained by low level of new capital in poor countries

No new capital --> no new savings --> no new investment --> no increased growth of economy

Solow Model

BackgroundSolow Model --> Study of convergence across an economyConvergence --> same level of income = the same rate of;

savings, sdepreciation, labor force growth, n productivity growth of labor given time (t), A(t)

Used Harrod Domar model as basisAK model --> Capital Labor model

Assumption Labor (L) and Capital (K) are the two factors of productionThe level of technology is exogenously givenThere are Constant Returns of Scale (CRS)

Increase in FoP's (Capital, and Labor) = Proportional Increase in Gross output (Y)

The production function is a Cobb-Douglas production function An equation that defines the inputs and output of producing goods and services

Diminishing marginal returns of inputs (capital and labor)Explanation

Note: lowercase variables express per-worker valuesCobb Douglas Production Function to illustrate CRS

Y(t)=K(t)^a(A(t)L(t))^1-a A(t), productivity of labor

OR yY=F(yK,yL)y is a positive variable to show growth, where y=1/L1/L*Y=f(K/L, 1) or y=f(k)

Final, y=Ak^a Y=Ak^a

k, capital per worker A, productivity of labor growtha, constant variableIn English: output per worker is determined by the amount of capital per worker

More capital, more output Note: exponents of the Cobb Douglas function a (alpha) and B (Beta or 1-a) represent output sensitivity of capital and output sensitivity of labor respectively Solow equation

Growth () of the capital-labor ratio, k (capital deepening) depends on savings, sf(k), allowing capital required to service depreciation (k), and capital widening, amount of capital per worker to net new workers going the labor farce, (nk)Solow Equation: k= sf(k)-(+n)k

Steady StateAssume, A is constantTherefore, state where output and capital per worker no longer change --> steady state Basically, adding more capital will not effect workers productivity, therefore k=0 Steady State equation: k=0 --> sf(k*)= (+n)k*

where * represents the point at which steady state is achieved Effect on per capita basis

increasing saving ratesdecreasing pop. growth ratedecreasing depreciation rate

Note: on the graph k is linear since it is a constant variableResult

When sf(k)>(+n)k, k>0; Savings > depreciation --> increase in capital stock --> growth of economy Also, Capital per worker increases --> savings > compensation

Compensation is the cost of depreciation, meaning the cost of replacing equipment

Therefore, economy grows to k*, steady stateInversely, sf(k)

Decreasing sf(k) --> decreasing output (y) --> decreasing capital (k* to k**), lower steady state equilibriumInverse for increasing savings, s'f(k)>sf(k)

NOTE: INCREASE IN s = INCREASE IN EQUILIBRIUM, NOT RATE OF GROWTHB/c w/ an increase in savings, economy adjusts and increases the capital labor ratio, output ratio also increases

Limitations Rate of savings can be influence by technological progress, A, but this is assumed constant, not in realityHarrod Domar vs Solow Model

Harrod Domar assumes linear production function, Solow assumes diminishing returnsSolow, increase in s will increase equilibrium not growth in long run. Harrod Domar uses increase in s, increases growth

ConclusionThe per capita variables grow at a rate zero while the aggregate variables grow at a constant rate of growth of population.

NOTE: Steady state reflect per worker, in aggregate, constant rate of growth is assumed

A change in the rate of savings or depreciation can change the rate of growth temporarily till the economy reaches a new steady state, where the rate of growth of the per capita variables are zero once more.A change in the rate of growth can only be brought about by a change in the level of technology, which is exogenously given in the model.The economy described in the model is a closed economy, so that the growth potentials from foreign aids and loans have not been looked into

Structural Change and the Lewis Model

Structural ChangeProcess through which the economic, industrial and institutional structure of an underdeveloped economy is transformed to replace traditional agriculture.Increased savings and investment are necessary but not sufficient conditions for growth. Structural changes required including change in production, composition in consumer demand, international trade, urbanization and growth and distribution of population.

Urbanization is good, urban giantism is not good because there too much surplus labor, unemployed, etc.

International constraints make transition of developing countries differ from the industrialized countries to the extent that they have access to capital, technology etc.Hollis Chenery cross country times series

identified shift from agricultural to industrial production, accumulation of physical and human capital, change in consumer demands from food to diverse manufactured goods, growth of cities, rural-urban migration etc. as features of development.

Background/AssumptionsThe economy has two sectors- agricultural and manufacturing The agricultural sector

Represents, over populated rural substance sectorSurplus labor --> MPL=0 (MPL= Marginal product of labor) Land is finite, at a point the surplus labor is too much and can not be efficiently utilized hence the MPL=0 Labor in the agricultural sector share the output equally such that wages are determined by the average product

Wages = Average Product, W=MPLThe manufacturing sector

High productivity, modern, urban industrial sector Output expansion= labor transfer and modern sector employment growth Output expansion is determined by; capital accumulation, rate of industrial investment

Investment due to excess profits, assumption reinvest profits Assumed, wages are constant, given premium over a fixed average subsistence level of wages (minimum wage)All wages are consumed and all profit are saved in the manufacturing sector The supply curve of labor is assumed to be infinitely elastic at the wage rate Wm in the manufacturing sector

Explanation/Diagrams

The Traditional Agricultural Sector

First diagram, typical agricultural production function, shows total output (TPa) determined by amount of labor (La), given fixed capital and technology

Subsistence, no savings all revenue to wages, therefore, TP(a)/L(a)=W(a)=AP(LA)Shows, MPL=0 since past point L(A), TP(A) remains constant, adding labor does not effect output (excess surplus)

Second diagram, average and marginal product of labor curves Derived from the total production curve from the 1st diagramThus, Quantity of agricultural labor (QLa) is the same in both diagramsImportant assumptions:

Wage=average product (not marginal product)Shown in digram, where L(A) and AP(LA) intersect giving W(A)

MPL=0Shown in diagram, at point L(A) since MP(L) (on the y-axis) is at 0

Modern Industrial Sector

TP(M) assumes constant capital stock, and technology, with a variable input of Labor

1st DiagramIn the modern sector, capital stocks can increase due to reinvestment of profits by insturial capitalistsTherefore, TPm(KM1) --> TPm(KM2) --> TPm(KM3) = outward growth of the production functionLabor also increases with increase in total production, more labor to produce more output, hence

L1 --> L2 --> L3 Second diagram

Increase in capital stocks, is illustrated by the second diagramAssumption: perfectly competitive, therefore MPL = Demand for Labor (D)

Proof: both curves are downward sloping

MPL=D=K(M)K(M) is capital stock, which is assumed to be constant, hence demand shapes MPL

W(A) is the wage from agricultural sector, or also, average rural incomeassumed to be unlimited or perfectly elasticTherefore, horizontal labor supply --> S(L)=W(M)

W(M), wage in modern sectorW(M) > W (A)

Because, at WM > WA, modern sector employers can hire as much rural workers w/o increasing wageImportant: this diagram represents modern as well as agricultural sectors

Modern sector gets labor from rural sector, since wages are lower in agricultural sector

Industry is profit maximizing, produce more output --> employ more laborHire more labor until point F, marginal physical product is equal to real wage Demand curve intersects with supply curve, D1(KM1)=S(L) at W(M) Therefore, the amount of labor employed will be at L1 The amount paid to workers in the form of wages is, 0*W(M)*F*L1The remaining gap on the D1 curve, W(M)*F*D1, that is profit from production

These savings are reinvested into production and allows for capital stocks to increaseTherefore, move to TP(M2), D2, G, L2, but keeping S(L) constant

The process of reinvesting savings into production is called "Self sustaining growth" Lewis Model Turning Point

Reinvestment and expansion occurs until all surplus labor is absorbedThereafter, additional labor withdraw from agricultural sector only at a higher cost of lost food production

B/c declining labor-to-land ratio --> MPL(rural) is not equal to zero

CriticismsSurplus labor in rural areas and full employment in urban may not be an assumption conforming to the real world Competitive modern sector labor markets guarantees existence of constant real urban wages until supply of rural labor is exhausted

Not true in realityCompanies can look to foreign labor markets for cheaper, abundant labor --> Outsourcing

Rate of labor transfer and employment creation may not be proportional to the rate of modern sector capital accumulation.

Reinvestment of profits in other sectors, example: laborsaving capital equipment

Labor-saving capital accumulation: Employment implications

Demand curve, D2(KM2) is more negatively sloped that D1(KM1), shows addition to capital stock embody laborsaving technical progress

Shows that investing in labor-saving methods will lead to decreased demand for labor

Output increases: from 0*D1*E*L1 to 0*D2*E*L1 Total wages and labor remains the sameRepresents: anti-developmental economic growth

all the extra income and output growth distributed to owners of capital, while income, employment levels for the masses remain unchangedThis is common in the developing world, through poor management, uncompetitive businesses, corruption

Model of Endogenous Growth Theory and The Romer Model

Motivation for Endogenous Growth TheoryAccording to the traditional theory,

There is no intrinsic characteristics of an economy that causes it to grow in the long run.In absence of shocks or technological change all economies converge to zero growth.

Thus, rising per capita GNI was always considered a temporary phenomenon resulting from;

Technological changeOr, a short term equilibrating process in which an economy approaches its long run equilibriumOR, due to the Solow Residual

Solow ResidualDefinition of Solow Residual: the proportion of long term economic growth not explained by growth in labor or capital and therefore assigned primarily to exogenous technological changeResponsible for roughly 50% of historical growth in industrialized nationsCriticisms/Limitations

Doesn't explain difference in residuals in countries w/ same technologyImpossible to analyze the determinants of technology change --> independent of economic agents decisions

New Growth TheoryAlso known as, endogenous growth theoryDefinition of New Growth Theory: economic growth generated by factors within the production process (e.g. increasing returns or induced technological change) that are studied as part of growth modelMain Objective of this model

Explain existence of increasing returns to scale Explain divergent long term growth patterns among countries

Analyzes endogenous growth (persistent GNI growth) determined by the system governing the production process rather than by forces outside that system.Used to show; differing growth rates, greater proportion of the growth observedExplains the Solow Residual by explaining factors that determine the size of , the rate of GDP growth

New Growth Theory vs. Neoclassical paradigmsDiscards neoclassical assumption of diminishing marginal returns to capital investments

Assumes increasing returns to scale to capital investments Focus on the role of externalities in determining the rate of turn on capital investment Assumes increasing returns to scale to aggregate production, rather than constant return to scale

New Growth models:Focuses on externalities to determine rate of returns on capital investmentsIncludes that savings and human capital investment is important for growthDoes not assume diminish marginal returns to capital investments

Allows for increasing returns to scale in aggregate production Explains anomalous international flows of capital that exacerbate wealth disparities

Neoclassical theory use the Harrod Domar model as the core of their argument, Y=AK

A= factor affecting technology, K= human/physical capital (includes labor) No representation of diminishing returns to capital

Doesn't explain the solow model production function, f(k), diminish slope

Main conflicts No force leading to equilibration of growth rates across closed economies

National growth rates differ or constant across different countries

No tendency for per capita income levels in capital poor countries to converge with that of capital rich countries with similar savings and pop. growth rates.

Romer Endogenous Growth ModelIllustrates New Growth TheoryModels technological spillovers (positive externality)

One firms or industries productivity gains lead to productivity gains in other firms or industries

AssumptionGrowth derived from the firm level, not aggregateIndustry produces w/ Constant Returns to Scale Economy-wide capital stock, K bar, positively affects output at the industry level --> increasing returns to scale Each firms capital stock includes knowledge (public goods (economy wide capital stock)--> technology spillover--> represented by A) Learning by doing ---> is now: learning by investing

Romer Model Equation

For the firm; Difference from Solow Model is the inclusion of K(bar) to Beta, includes economy wide capital stock which positively affects output

For the industry;Assumed to have same capital and labor

Showing endogenous growth; Assume:

that "A" is constant, no technological progress per capita growth = 0 No spillover

g is output growth rate, n is population growth rate,However, Romer assumption of positive capital externality B>0, we have that;

g-n>0 and that Y/L is growing

Therefore, proving endogenous growth

Criticisms of Endogenous Growth TheoryRemains dependent on a number of neoclassical assumptions. For example, there is a single sector of production or that all sectors are symmetrical. This does not permit the crucial growth generating reallocation of labor and capital among the sectors that are transformed during the process of structural changeEndogenous growth theory overlooks complementary investments: growth impeding inefficiencies arising from poor infrastructure, inadequate institutional structures and imperfect capital and goods markets.Fails to explain low rates of factory capacity utilization in low income countries where capita is scarce

Neoclassical Dependence Model

The International Dependence RevolutionDuring 1970s, this gained increasing popularity resulting from discouraging outcomes from the stages and structural models.Definition: These models view developing countries as beset by domestic and international institutional, political and economic rigidities, and caught up in a dependence and dominance relationship with rich countries.Three schools of thought

Neocolonial dependence modelFalse-paradigm modelDualistic-development thesis

The Neocolonial Dependence ModelIndirect result of Marxist thinning Attributes the existence of underdevelopment primarily to the historical evolution of an unequal international capitalist system of a rich country and poor country relationship.

Rich countries generally in northern hemisphere The coexistence of rich and poor countries means that the rich nation dominate the poor nations through economics such that the poor can not be subsistentThis theory emerged out of the colonization movement

The coexistence of rich and poor nations in an international system is dominated by an unequal relationship between the center and the periphery. Thus, attempts by poor nations to be self-reliant and independent is difficult.

Core and periphery relationship is assumed here

Core needs periphery to sell surplus production and for a source of labor (brain drain)This practice creates a duality such that the status of rich and poor nations does not change and continues to clash

Directly or indirectly, the small but powerful elite ruling class serve and are rewarded by international interest power groups like MNCs, national bilateral and multilateral agencies.

Bilateral and multilateral agencies are the World Bank and IMFRich countries influence are exercised by domestic actors known as the elite or comprador groups

The False-Paradigm ModelAttributes underdevelopment to faulty and inappropriate advice provided by well-meaning but uninformed, biased and ethnocentric international advisers from developed-country assistance agencies and multilateral donor organizations There are advisors and experts that make policy recommendations in good faith however, this recommendations do not match the economic structure of your economy

Fails to account for domestic conditions in developing countries;Social structure, income disparities, etc.

The Dualistic-Development Thesis Dualism: the existence and persistence of substantial and even increasing divergences between rich and poor nations and people

In international dependence, dualist societies exist, the rich countries and poor countries

Four Main Arguments: 1. Different sets of conditions, of which some are superior and others inferior can coexist in a given space.

An example includes the Lewis model notion of the coexistence of the modern and traditional methods of production in urban and rural sectors.

2. This coexistence is chronic; not transitional and not due to temporary phenomenon

Simply: International coexistence of wealth and poverty is not simply a historical phenomenon that can be resolved given time

3. Not only do the degrees of superiority or inferiority fail to show signs of diminishing but they have an inherent tendency to increase

For the rich, the borrowing ability is higher because they have enough collateral to access capitalFor the poor, the borrowing ability is low due to low collateral hence they can not produce enough to escape poverty Therefore, the rich to poor gap simply keeps on getting bigger

4. Superior and inferior interrelations are such that the existence of superior elements does little or nothing to pull up the inferior element, let alone trickle done to it.

In fact, it may actually serve to push it down- to develop its underdevelopment Constantly stuck in the poverty cycle

ImplicationsAll three schools of though reject the exclusive emphasis on traditional neoclassical economic theories Emphasis on international power imbalances and need for both domestic and international on economic, political and institutional reform

Criticisms/Limitations

Although they offer an explanations about why many poor countries remain underdeveloped, they provide no insight into how countries initiate and sustain development.The actual economic experience of developing countries that have pursued revolutionary campaigns of industrial nationalization and state-run production has been mostly negative.

Basically, all revolutions have been "crushed" and has not been sustained If taking these paradigms into reality, the only manner in which the imbalances can be correct is through;

Policies of autarky: Closed economy, self reliantHowever, stagnation can occurs. Example; China in 1970s

Inwardly direct development To rural areas rather than urban areasAccess marginalized/remote areasDifficult to achieve, developing countries characterized by poor infrastructure to access these areas

Trade with only developing countries Contradicts assumption of free market, open trade

Chapter 4: Contemporary Models of Development and Underdevelopment

Purpose

To understand that development is harder to achieve because it faces more number of barriers than had been previously recognizedTo conclude with a framework for appraising the locally binding constraints on the ability of a developing nation to further close the gap with the developed world

Coordination Failure

Coordination Failure: a situation in which the inability of agents to coordinate their behavior leads to an equilibrium that leaves all the agents worse off compared to an alternative equilibrium Complementarities exist in these situation

Complementaries: an action taken by one firm, worker, or organization increases the incentives for other agents to take similar actionsOften refers to investments, return on investment depends on other investments being made by other agents

Models derived from Coordination Failure and complementarities: Big Push --> decisions taken by firms are mutually reinforcing O-ring model --> value of upgrading skills depends on similar upgrading by other agents The middle income trap

This might occur despite perfect information about the alternative equilibrium Preferred alternative not reached due to;

Difficulties in coordination,

Different people holding different expectations, and Because everyone waits for someone to make the first move

Example of Complementarity: Firms using specialized skills and availability of workers who have those skills

Firms won't enter a market that does not have firms w/ these skillsTherefore, worker will not acquire the skills if firms don't demand to employ themCoordination problem--> economy stuck @ bad equilibrium

Low average income or growth rate Or class of citizens in poverty trap

Firms and workers are better off w/ skills, but no agent providesEXECPT: for government intervention through education

Example of Complementarity: Rural developing areas & commercialization of agricultureThe Underdevelopment Trap is an example of Complementarity

Definition of the Underdevelopment Trap: A poverty trap at the regional or national level in which underdevelopment tends to perpetuate itself over time

Rural areas, specialize in agriculture, division of labor as wellSpecialization MUST BE complemented with tradeRural areas, producers can't go to market and trade, need for a middlemenMiddlemen, determines quality --> subjective process, hard to determine qualityNeed for a sufficient concentrated number of middlemen

Often times not the case, rural producers are unaware of process, prone to extortion

W/o effective middlemen, little incentive to specialize and produce surplus, reamin in subsistence

Multiple Equilibria

Definition of Multiple Equilibria: A condition in which more than one equilibrium exits. These equilibria may sometimes be ranked, in the sense that one is preferred to another, but the unaided market will not move the economy to the preferred outcome Multiple Equilibria Diagram

IMPORTANT NOTE: Axises compare expected investment levels by other agents vs. individual investments levels S-Shape curve = Privately rational decision function

Represents the expectations of decision makers --> Producers, investors, etc. Shape is due to the benefits an agent receives is dependent positively on how many other agents are expected to take the action or on the extent of this actions

First increases at an increasing rate, then at a decreasing rate Initially, few agents take action, assumed isolation. Spillover is minimal --> slow increaseAfter enough investment, spillover benefit begin, curve rises faster Most investors have been positively affected and the important gains realized --> rate of increase slows

Example: Underdevelopment trap, rural producers produce depending on the number of active middlemen which determine the number of other farmers who specialize in the same product

Equilibrium, is when the privately rational decision function (S curve) crosses the 45 degree line (blue line)

The process of adjustment along the S curve continues until the level of actual investment is equal to the level of expected investment

Basically when the x and y-axis are equal, when S-curve intersects blue lineReasoning: Assume firm expects no investment but some firms invest, firm then revise their expectations to be higher (expect investment) such that they match the expectations of the few firms that did invest.

However, when investment is matched, other agents expect even more investment, causing revision of individual expectations, hence a new equilibrium is created.This process continues, creating multiple equilibrium

There is no reason for firms to adjust their expectations any further at this pointEquilibrium occurs at three points--> D1, D2, D3

D1 and D3 are Stable EquilibriaS Curve cuts the blue line from above --> hallmark of stable eq. If at these points, slight change to more or less than eq. levels, firms will revise investment levels to go back to original eq. levels

D2 is an unstable equilibria If expectations are lowered, then the equilibrium will shift to D1 rather than having revision of investments downwardIf expectations are increased, then the equilibrium will shift to D3 rather than having revision of investments upwardD2 is an equilibrium only by chance, serves as a division between higher or lower stable equilibrium

The Big Push

BackgroundMost famous model of coordination failuresPaul Rosentein-Rodan Industrialization is difficult to achieve, stagnation often plagues development from a subsistence economy to a modern economy (i.e. Argentina) Big Push --> presence of market failures can lead to a need for a economy-wide and public policy led effort to get the long prices of economic development underway or accelerated. Workers spend income on variety of goods, not only to produce (shift away from subsistence during industrialization) Profitability of one firm depends on whether one opens, etc. (creating a market)

Coordination failure, dependent on other agents actionsWorkers need to be trained. However, if other firms can employ these skilled workers at a sightly higher wage given that they train them, no firm anticipating this will pay for the training

Coordination failure Key assumption: economy does not export

AssumptionsLabor is the only factor of production. Supply is fixed Labor Market

Traditional sector, wages are fixed and are represented by the numeraire "1"W(T)=1 If wage is 35 pesos, we say that wage is 1 for mathematical reasons

Modern sector, wages are greater than one, W(M)>1Technology: there are N types of products

Traditional sector, 1 worker = 1 unit of output --> Constant Returns to ScaleModern Sector,

Minimum of F workers must be employed to produce (fixed cost) Modern sector production > traditional sectorL=F+cQ, where c

Domestic demandNo savingsAll income spent on goods constantly and equally hence, Y/N is spent on each good

International supply and demandEconomy is closed, no exports

Market structure Traditional sector is;

competitive, free entry, no economic profit, price set at 1 At most, one modern sector firm can enter the sector

Comes from Increasing returns to scale Charges price of 1, b/c of potential competition from traditional sector Monopolist unit elastic demand

Diagram

ExplanationSuppose traditional economy w/o modern production in any market Potential producers w/ modern tech. considers

1) efficiency of both sectors 2) wages in both sector

Price is 1 so P*Q=Q Traditional sectors production function

Linear, slope of 1 --> constant returns to scale, one worker for one unit of outputWages are equal to production (no savings), hence traditional wages are the same as the production function

Modern sector production functionMust acquire F amount of Labor to produce, so starts from F Afterwards, linear technique w/ slope 1/c>1 --> signals more efficient productionWages must be higher than traditional, hence W>1

Point AModern firm will produce if it enters the traditional sector, given tradition firms operating. Entry is dependent on profitability

If W1 is the wage bill line, W1 is below Point A, hence the production is greater than the costs (wages) --> profit is made Enter the market, pay F amount of laborRemember: all goods are equal, producing one goods can also mean other goods, aggregate effect on all goods hence the economy through this assumption From Point A, the modern firm enters the market, produces all goods, demand increases enough to move upward to Point B This shows that coordination failure does not have to happen

If W2 is the wage bill lineThis line passes between Point A and B hence causing a multiple equilibria conditionEquilibrium 1

Greater than Point A, costs are greater than production --> incur losses --> Don't enter the market

Equilibrium 2If modern firms enter all market, wages increase to modern wage in all markets --> REQUIRES COORDINATION AMONG AGENTS Increase to Point B will greater demand through entry, realize profits Price remains at 1 This will not occur b/c of coordination failure

If W3 is the wage bill oneEven if modern firms enter all markets, loses will still be incurred, traditional firms remain

When wage bill line passes below Point A, industrialization occurs if above, no industrialization

Criticism/Limitations Doesn't assume technological externalities

Application of the Big Push in;Intertemporal effectsUrbanization effects

Modern techniques prevent traditional techniques to consumed by urban dwellers, need for a big push for urbanization to achieve industrialization and develop traditional techniques

Infrastructure effectswhen one product sector industrializes --> increase size of market --> Increase use of infrastructure services that would be used by others --> more profitable No need for new firms to make a new railroad if its already built by already present firms in the market

Training effectsUnderinvestment in training facilities by firms b/c workers may be enticed by higher wages offered by rival firms w/o training costs Little demand by workers for training, they don't know what they need

O-Ring Model

Definition: the value of upgrading skills or quality depends on similar upgrading by other agents Explains existence of poverty traps Key Feature --> models production w/ strong complementarities among inputsModels production with strong complementaries among inputs

Modern production requires that many activities be done well together in order for any of them to amount to high value

Concept of "q" Production process as n tasks.q --> level of skill required for production0 q 1, the more q, the more level of skill --> the probability task will be successfully completed Flexible use of q, other interpretations include quality index for characteristicsAssume, probability of mistakes by different workers is strictly independent--> no control of these factors.

O-Ring Production FunctionBF(qiqj) = qiqj; B = 1Multiplying the q values of each of the n tasks together,Assumption here is that there are only two tasks hence only qi and qj.This production function is multiplied by B, depends on the characteristics of the firm

AssumptionFirms are risk neutralLabo markets are competitive Labor supply is inelasticEconomy is closed

Positive assortative matchingWorkers with high skills will work together and workers with low skills will work togetherCreating two categories of workers:

High skilled --> qHLow skilled --> qL

Assume four-person economy, two high skilled worker and two low skill workersFour workers can be arranged either as matched skill pairs or unmated skill pairsTotal output is higher under matching scheme b/c

qH2 + qL2 > 2 qHqLResult: workers sort out by skill level

Cascade effect: Some firms and workers, even an entire low-icome economy can fall into a trop of low skill and low productivity while others escape into higher productivity

Higher productivity workers will tend to group together, they are hired yb firms b/c it is profitable to doLeaving group of less productive workers stuck, other less competitive firms hire themSame applies with multiple skill levels, highest productivity workers--> second highest--> third, fourth,etc --> low productivity workersThe cascade effect shows that the O-Ring Model is consistent with competitive equilibrium

Positive assortative matching, dependent on two assumption;Workers must be sufficiently imperfect substitutes, two different skilled worker categories Sufficient complementarity of tasks --> n tasks must be the same for both high and low workers

Implications of the O-Ring Theory Firms tend to employ worker with similar skills for their various tasksWorkers performing the same task earn higher wages in a high-skill firm than a low-skill firmLow skill workers are incentivized to improve their skill level through investments due to the presence of higher average skills. Remember: Competitive labor marketEconomy-wide low-proudction-quality traps, due to externality at work, causes policies to encourage quality upgradingO-ring effects can magnify the impact of local production bottlenecks b/c such bottlenecks have a multiplicative impact on other productionBottlenecks also reduce the incentive for workers to invest in skills by lowering the expected return to these skills

Chapter 5: Poverty, Inequality and Development

Questions on the relationship among economic growth, income distribution and poverty

What is the extent of relative inequality in developing countries?How is this related to the extent of absolute poverty? Who are the poor and what are their economic characteristics? Do the poor benefit from growth, and does this depend on the type of growth a developing country experiences? What is so bad about high levels of inequality? What kind of policies are required to reduce the magnitude and extent of absolute poverty?

Measuring Inequality

Income inequality (Definition): the disproportionate distribution of total national income among households/individuals Two principal measures of income distribution

Personal/size distribution of incomeFunctional/distributive factor share distribution of income

Personal/size distribution of incomeDefinition: the distribution of income according to size class of persons without

regard to the sources of that incomeThe measure most commonly used by economistsDeals with individual persons or households and the total incomes they receive.Ignores sources of income (urban or rural, agriculture or manufacturing, invest or gift, etc.)Order individuals by ascending personal income and then divide the total population into distinct groups and size. Division of total population can be by either deciles (tenths) or quintiles (fifth) Measuring personal income equality; Kuznets ratio and Lorenz CurveKuznet's ratio

Divide population into deciles or quintiles, use this division to get absolute percentages of income share of sections of the populationRatio of incomes received by the top 20% and the bottom 40% Basically: Top 20% / Bottom 40% The bigger the number, the larger the income inequality between low and high income groups

Lorenz CurveDefinition: Plots cumulative income against percentage of population

Constructive Lorenz CurveFigure out Income % of each decibel or quartile Figure out Cumulative Income % of each decibel or quartilePlot on graph

Cumulative percentages, not in absolute percentages

Example, at 20 mark, represents Bottom 20%, 60 mark, represents Bottom 60%, so on and so forth

At 100 mark, represents all the income in the economyLine of Perfect Equality

Represents the ideal goal of proportional income distribution Percentage of income recipients = Percentage of income

Lorenz curve, shows actual quantitative relationship between % of income recipients and % of incomeThe greater the Lorenz Curve is from the Line of Perfect Equality --> greater the degree of income inequalityThe smaller the Lorenz Curve is from the Line of Perfect Equality--> smaller the degree of income inequality

Gini Coefficient

Definition: An aggregate numerical measure of income inequality raining from 0 (perfect equality) to 1 (perfect inequality), measured graphically by dividing the area between perfect equality and the Lorenz curve by the total area lying to the right of equality line in a Lorenz diagram Large Gini coefficient --> more income inequality

Typically, 0.5 to 0.7Small Gini coefficient --> less income inequality

Typically, 0.2 to 0.35Lorenz Criterion

Whenever one Lorenz curve lies above anoth Lorenz curve, the economy of the above Lorenz curve is said to be more equal

If two different Lorenz curves intersect at any point, require more information or additional assumptions to make the distinction between which economy is more equal

Dualistic Development and Shifting Lorenz Curves: Some Stylized TypologiesThree cases that limit dualistic development (modern/traditional sectors)Modern sector enlargement growth typology; Two sector economy develops by increasing the modern sector while wages remain the same in both sectors. Same concept in the Lewis Model

Results: absolute income rises, absolute poverty is reduced, Lorenz curves cross each other, indicating change in the proportionality of equality distribution so that inequality is worser at first and improves above the original Lorenz curve over time

Modern-sector enrichment growth typology; economic growth is limited to a fixed number of people in the modern sector, with both the numbers of workers and their wages held constant in the traditional sector

Results: higher incomes, less equal relative distribution of income, and no change in poverty, Lorenz curve shift downward

Traditional-sector enrichment growth typology: benefits of growth are divided among traditional-sector workers, with little or no growth occurring in the modern sector.

Policies at achieving substantial reduction in absolute poverty (Sri Lanka) Results: higher incomes, more equal relative distribution, less poverty, Lorenz curve shifts upwards

Criticism of the Lorenz CurveIncome measurements to determine poverty is politely, income is dependent on currency which is determined in turn by exchange rate and thus is a

volatile measurement over a given period of timeOther measurements that are more stable in measurement include consumption patterns and wealth in terms of real estateHowever, income is an easier determinant of poverty to calculate

Functional Distribution of income (Factor share distribution of income)Definition: to explain the share of total national income that each of the factors of production receivesDiagram

Supply and demand curves determine the unit price of each productive factorUnit price multiplied by the quantities employed on the assumption of efficient (minimum costs) factor utilization --> total payment to each factor In the diagram --> Labor Market

Assume two factors, capital (is fixed) and labor (variable) In the labor market, wage rate = Price Price determined by demand and supply of laborNote: total output= payment to labor+profitsTotal output= 0*R*E*L Payment to labor (Wages) = 0*W*E*L Profits=W*R*EThis is for labor market, can be replicated for other payments to FoP's (rent, interest, and profits)

CriticismsDoesn't factor non-market forces like bargaining through unions

Measuring Absolute Poverty

Definition of Absolute Poverty: The situation of being unable or only barely able to meet the subsistence essentials of food, clothing and shelterAbsolute poverty is measured by the headcount (H) of those whose incomes fall below the absolute poverty line (Yp)Absolute poverty line --> $1.25 a day or $2 per day in PPP dollars

Determinants of Absolute povertyLow per capita incomeHigh unequal distribution of income

Headcount index/Headcount ration (HCR)Definition: when the headcount is taken as a fraction of the total population (N)Headcount = per capitaIndex: H/N

Total Poverty GapDefinition: measures the total amount of income necessary to raise every who is below the poverty line up to that line Calculated by adding up the amount by which each poor persons income, Yi, falls below the absolute poverty line, Yp ,

Formula for Total Poverty Gap: TPG = Hi=1 (Yp Yi)Simply: the amount of money per day it would take to bring every poor person in an economy to minimum income standards Total Poverty Gap Diagram

Poverty Gap RatioPGR= (Income of poor - (sum of the income of poor people/number of poor people) / Income of poor

Average Poverty Gap APG= TPG/NPer capita basis

Normalized Poverty GapTo measure the size of the poverty gap of the poverty lineNPG= APG/YpMeasure lies between 0 and 1

Average Income ShortfallMeasures the average amount by which the income of a poor person falls below the poverty line

AIS= TPG/HNormalized Income Shortfall

NIS= AIS/YpThe Foster-Greer-Thorbecke Index

Definition: a class of measures of the level of absolute povertySatisfies four characteristics

Anonymity & Population IndependenceOur measure of the extent of poverty should not depend on who is poor or on whether the country has a large r small population

MonotonicityIf you add income to someone below the poverty line, all other incomes held constant, then the poverty line can't increase

Distributional Sensitivity Other things held constant, income is transferred from poor to rich persons, the economy is deemed strictly poorer

Headcount ratio measures anonymity, population independence and monotonicity but not distribution sensitivityFoster-Greer-Thorbecke Index measures Distribution Sensitivity

FormulaP = (1/N)Hi=1 [(Yp Yi) / Yp]

P --> class of poverty measuresYi --> Income of the ith poor personYp-> the poverty lineN --> populationH--> headcount

Conditions If =0 , P=P0= H/N (Headcount ratio)If =1,

P=P1=APG/Yp=NPGP=P1= HCR * PGR

If =2, P=P2=(H/N)[NIS^2 + (1-NIS)^2*(CVp)^2]Used commonly in the World Bank and other agenciesSensitivity to the depth and severity of poverty

Poverty, Inequality, and Social Welfare

Assumption, that social welfare depends on level of per capita but negatively on poverty and inequality Inequality among the poor is a critical factor in determine the severity of poverty. But why should inequality among those above the poverty line, be of concern!

Extreme income inequality leads to economic inefficiency Poor can not get loans to produceRich get loans but don't save and invest significantly larger proportions of their income than other classesInefficient allocation of assets, high inequality --> focus on higher education rather than universal primary education

Extreme income disparities undermine social stability and solidarity and strengthens the political power of the rich and hence their economic bargaining power.

With high inequality, politics focuses on redistribution of existing economic pie rather than expanding it

Extremem inequality is generally viewed as unfairVeil of ignorance: the uncertainty of of the overall level of inequality on is born in toDifferent income levels gives workers the incentive to work, different income thus entails that income inequality is present, hence a degree of inequality is needed

Welfare EquationW=W(Y,I,P)Where W is welfare, Y is income per capita, I is inequality and P is absolute povertyNote: inequality and absolute poverty reduce welfare, therefore they are negative values Meaning, welfare is a function of income per capita, inequality, and absolute poverty

Kuznet's Inverted-U Hypothesis

Definition: suggests that in early stages of economic growth, the distribution of income will tend to worsen; only at later stages it will improve Characterized by an "inverted U'' Kuznets curve Diagram

ExplanationReflects structural change ideas that inequality may worsen during early stages of economic growth, Lewis Model where in early growth, modern sector is concentrated on w/ limited employment and wages/productivity are high Assuming modern sector enlargement growth, alternatively returns to education may first rise as the emerging modern sector demands skills and then fall as the supply of educated workers increases and the supply of unskilled worker falls

Poverty and Growth

Are poverty and growth complementary? Traditional argument- Rapid growth is bad for the poor because they will be bypassed and marginalized by the structural changes of modern growthFive reasons; that promote rapid economic growth and reducing poverty are not mutually

conflicting objectives

1. Widespread poverty creates conditions in which the poor can not access credit1. Can not finance child education, no improvement in skills or opportunity to enter

modern sector 2. W/o access to credit, poor can't act for themselves and exist poverty, slows potential

productivity 2. The rich in many poor countries are generally noted to not dave and invest substantial

proportions of their incomes in the local economy1. Capital Flight--> Lack of reinvestment causes less growth in the economy

3. The poor are characterized by not only low income but also, poor health, nutrition and education, which can lead to lower economic productivity and thereby directly/indirectly to a slower-growing economy

1. Improving income also means improving living conditions which can increase productivity

4. Raising the income levels of the poor will stimulate an overall increase in the demand for locally produced necessity products f

1. Example; Food and clothing2. Rich tend to spend income on luxury goods3. Higher demand, raises local production/employment/investment --> rapid economic

growth 5. A reduction in mass poverty stimulates healthy economic expansion as a psychological

incentive to widespread public participation in the development process 1. Increased productivity boost from the psychological incentive

These goes of achieving both poverty reduction and economic growth are from policies that encourage modern-sector enlargement

Economic Characteristics of High-Poverty Groups

BackgroundMagnitude of poverty results from a combination of low per capita incomes and highly unequal distribution of the income For any given distribution of income, the higher the level of per capita income, the lower the numbers of the absolutely poor. Higher levels of per capita income are no guarantee of lower levels of poverty An understanding of the nature of the size distribution of income is therefore central to any analysis of poverty problem in low income countries

Rural PovertyPoor disproportionately in rural areasEngaged in agriculture (about 2/3 of the very poor)Most likely to be women/children than men working in agricultureConcentrated along minority ethnic groups and indigenous peoples Other engage in petty services (about 1/3 of the very poor)

In marginal/fringes of urban populationsMajority of government expenditures are directed towards urban areas towards manufacturing and commercial sectors (urban modern sector bias).

Women and PovertyMajority of the world poor are womenWomen and children experience the harshest depreciation of the poor Influencing factors: Prevalence of female headed household, the lower earning

capacity of women, and their limited control over their spouses income Less access to education, formal sector employment, social security and government employment programs Wage differentials exist between men and women performing similar jobs. In many cases women are banned from high paid jobs

Ethnic Minorities, Indigenous Populations and PovertyIn general the incidence of poverty in developing world falls heavily on minority ethnic groups and indigenous populationsIf higher income can be achieved poverty can be reduced since greater resources are available to tackle problems 40% of states have more than five sizable minority groupsFace economic, social, political and cultural marginalization Indigenous people's poverty, >300 million in >5,000 different groups in >70 countriesMajority of indigenous groups live in extreme poverty Being indigenous increases the chances that individual is malnourished, illiterate, in poor health, and unemployed

Policy Options on Income Inequality and Poverty

Four major elements in the determination of a developing economy's distribution of income;

1. Altering the functional distribution 1. Functional distribution= returns to labor, land and capital= wages, rent, interest

2. Mitigating the size distribution 1. Size distribution by knowledge of how ownership and control over productive assets

and labor skills are concentrated and distributed through the population3. Moderating (reducing) the size distribution at the upper levels

1. Through progressive taxation of personal income and wealth4. Moderating (increasing) the size distribution at the lower levels

1. Through public expenditures of tax revenues to raise the incomes of the poor

Policy recommendations, instead of one or two isolated policies but for a "package" of complementary and supportive policies, four basic elements to include

1. A policy or set of policies designed to correct factor price distortions (underpricing capital or overpricing modes sector skilled wages)

1. To ensure that market or institutionally established prices provide accurate signals and incentives to both producers ad resource suppliers

2. Result: greater productive efficiency, more employment, and less poverty2. A policy or set of policies designed to bring about far-reaching structural changes in the

distribution of assets, power, and access to education and associated income-earning (employment) opportunities

1. Result: wil increase the chances of improving significantly the living conditions of the masses of rural and urban poor

3. A policy or set of policies designed to modify the size distribution of income at the upper levels

1. Through the enforcement of legislated progressive taxation on income and wealth and at the lower level through direct transfer payments and the expanded provision of publicly provided consumption goods and services (government spending)

4. A policy or set of policies designed to directly improve the well-being of the poor and their communities

1. Beyond safety net schemes2. Offer programs that build capabilities and human & social capital of the poor3. Example: microfinance, health, education, agricultural development, environmental

sustainability

Chapter 6: Population Growth and Economic Development

Purpose A look at the historical and recent population trends and the changing geographic distribution of the world populationPresent some well-knwon economic models and hypotheses regarding the causes and consequences of rapid population growth in LDCsControversies surrounding the significance of the population factor in general and these models are exploredA range of alternative policy options that developing countries may wish to adopt explore to influence the size and growth of their population is evaluated

Facts, Past, Present and FutureDoubling time - period of time that population or a unit of quantity requires to increase by its present size Human mortality lowest in human history

Due to technological advancement in medicine, and modern sanitation Result: population growth increase worldwide

Structure of the World's PopulationGeographic Region

More than 3/4 of world pop. in developing nationsDeveloping nation have highest populations (China 1st and India 2nd)

Fertility and Mortality TrendsRate of population growth = natural increase - net international migration Natural increase = births rates - death rates = fertility - mortality

Developing nations birth rate: 15-40/1000Developed nations birth rate: less than 15/1000

Total fertility rate (TFR) - number of children a woman would bare if living to end of childbearing years (15-49 years) assuming age-specific fertility rates Technological advancement ---> Modern medicine = drastic reduction in death ratesLife expectancy at birth - number of years a newborn child is expected to like given mortality risks at the time of birth Under-5 mortality rate - deaths among children between birth and 5 years of age per 1,000 live births

Age Structure and Dependency BurdensYouth dependency ratio - the proportion of youth (>15) to working population (16-64) in a given nation

Very high ratio in developing nation, more than 40% in some nations Rapid pop. growth = greater youth dependency ratio, more difficult to supportHidden Momentum of population growth: population increases after birth rates fall b/c large existing your pop. expands the pop. base of potential

parents Due to high birth rates cannot be altered substantially overnight Relates to age structure (population pyramids) - developing nations tend to have bottleneck population pyramid --> reflect this phenomenon When youth reach adulthood, number of potential parents increase equally

The Demographic TransitionDefinition of Demographic Transition: The process by which fertility rate eventually decline to replacement levels is illustrated by the concept of demographic transition

Stages of Modern Population History - Developed CountriesStage 1

Prior to modernization, stable or very slow growing population Combination of high birth rate and equally high death rates

Stage 2Modernization = improved diet, medicine, etc.Reduction in mortality --> gradual raise in life expectancy (under 40 to over 60) The decline in death rates not immediately accompanied by a decline in fertility Growing divergence b/w high birth rates and low death ratesSharp increases in pop. growth ---> +2% per annum Stage 2 marks the beginning of the demographic transition (low pop. growth to high pop. growth)

Stage 3Modernization and development --> cause decline in fertilityReduced fertility = lower birth rates converging with lower death ratesThus little or no pop. growth Opposite to Stage 1 Decline in pop. growth rate depends on factor such as: pandemics and disease, gov't policies (family planning, etc.)

The Malthusian Population TrapThomas Malthus, 1798 essay Essay on the Principle of Population Theory of relationship b/w population growth and economic developmentCompares population growth curve and aggregate income growth rates against levels of per capita income Concept of diminishing returns used

Diminishing returns to fixed factors (land, food supplies) --> increase arithmetically Declining marginal contribution to food production of added member of population

Population growth --> geometric rate, doubling every 30-40 years Tension b/w fixed factor and population

Food supply growth can't keep up w/ population growth --> per capita income falls --> leads to stable population existing barely/slightly above subsistence

Malthusian Population Trap = Low level equilibrium population trap Threshold population level : when an increasing population (geometric rate of growth) due to life sustaining resource (arithmetic rate of growth) are insufficient to support human population Population Trap: low level of income, low population growth = stuck in

subsistence economyLow production, medicine, poverty, living standards, etc.

Avoid poverty by having "moral restraint" ---> modern birth control movement Diagram Explained

X-axis = level of income per capitaY-axis = population growth and total income growthTwo curves

Population growth curve = (change in Population/total population) Trend: Increases exponentially (3-4%) --> stable population is reached (near 0%) --> then declines

Total Income Growth Rate = (change in income/total income) Below the x-axis

Total income is very low --> starvation, diseases, etc.--> very low populationPopulation grows after reaching minimum level of income per capita

Increased income, improved nutrition, medicine Per capita income growth = difference b/w income growth and population growth = (Y/P)Change in Income - Change in Population > 0 = Income per capita increases = shift to the right Change in Income - Change in Population < 0 = Income per capita decreases = shift to the left Change in Income - Change in Population = 0 = Income per capita is constant

This defines equilibria = therefore, this condition is present at A, B and C Total incomes increases as economy and income per capita increases

Assumption: savings vary positively w/ income per capita (more savings = more income growth)

Demographic transition and Malthusian Stage 1 = A, Stage 2 = B, Stage 3 = C

Stable Equilibrium at A and C Move left or right of A or C, return back to A or CTo the left of A or C = Total income growth > population growth --> income per capita increasing --> shift rightward to A or CTo the right of A or C = Total income growth < population growth --> income per capita decreasing -> shift leftward back to A or C

Unstable Equilibrium at B Move left or right of B, don't return back to B

Malthusian Population Trap in the DiagramEconomy will always stay at point A (subsistence) unless checks (birth control) are not made to reduce population growth and increases total income --> therefore shifting towards B Above A -> pop. growth > income growth --> decrease income per capita --> stuck and back to A

High-Fertility Trap??? X-axis = expected fertility Y-axis = family's own fertility decision Upward sloping response of owner fertility to average fertility caused by:

Larger family increase likelihood of offspring getting modern jobsFamilies follow local social norms about fertility

Equilibrium - expected and decision of fertility is met

Criticisms of the Malthusian ModelDeterminant of pop. growth rates is assumed to be per capita income. Better option to look at individual/family decisions on family size --> Microeconomic Household Theory of Fertility (see below) National rates of population increase are directly related to the level of national per capita income

Relatively low levels of per capita income, expect population rates increasing w/ increasing per capita income

Ignores the enormous impact of technological progress in offsetting the growth-inhibiting forces of rapid population increases

Increasing rather than decreasing returns from technology help avoid Malthusian TrapMalthusian in 1798, could not predict the advancement in technology Technological and Social Progress to Avoid the Population Trap

Alternative to Malthusian Trap, there can be no intersection of the two curves Due to technological progress --> shifts income curve up at any level of per capita income Social progress of civil society and institutions --> shifts pop. growth curve down Population trap eliminated --> economy remains self-sustaining

No intersection of income curve and population growth

Income per capita never decreases since total income growth > population growth

Microeconomic Theory of Fertility Definition: family formation has costs and benefits that determine the size of families formed Stems as a criticism of the Malthusian Population Trap Microeconomic determinants of family fertility to explain fall in birth rate at Stage 3 of the dem. transitionUsing consumer behavior:

Individuals tastes and presences for a range of goods (utility function) to max. satisfaction given budget constraints (income).

Theory of Fertility Children= special type of consumption Fertility = rational economic response to the consumers (family's) demand for children relative to other goods Assume income/substitution effect

Demand for Children

Direct relation with Y = household income

Inverse relation with Pc = Price of Children, Px = Price of other goods, tx= tastes for other goods

DiagramDemand for Children - Cd - on the x-axis Household desire for children, expressed by indifference curves Any point on a higher indifference curve represents a higher level of satisfaction than any point on a lower indifference curveTheory: infinite indifference curve, only four in the model Children assumed to be normal goodsOriginal Budget constraint = line ab = slope of ab represents expected income and relative prices of children and goods

Below the budget constraint --> financially attainable Steeper the slope, the higher the price of children relative to other goods Optimal bundle - point f, given Indifference curve I2

Household income increases --> budget constraint shift outward from ab to a'b'

Higher satisfaction --> increased indifference curve to I4Consume both bundle of goods and children --> optimal bundle is now h

Increase in price of children relative to other goods (increase in opportunity costs) --> households substitute commodities for children

Lower indifference curve (f to e) Budget constraint slope is steeper (from ab to ab'') --> shows increased opportunity costs

Simultaneous increase in household income and cost of childrenB/c of female employment opportunitiesBudget constraint shift outward and downward ---> line cdUtility max = less children per family (from f to g = c3 to c2)Result: higher levels of living for low income families w/ relative increase in price of children = motivate households to have fewer children w/ improved welfare

SummaryRealistically, simultaneous increase in income and cost of children will occurExpanded efforts for jobs, education, health for poverty groups and women --> better welfare economically and physically Also contribute to motivate households to have small family size --> reduces population size and still increase growth Family planning programs can aid in adjusting this phenomenon

Population growth - Not a cause for concern The problem is not growth of population but other issuesPopulation growth is a false issue deliberately created by dominant rich-country institution to keep LDCs in an underdeveloped, dependent condition For many developing countries population growth is desirable

Other IssuesUnderdevelopment - w/ correct strategies = higher living standard, self-esteem, freedom --> pop. take care of themselves

Some argue birth control programs will fail - no motivation to lower family size Population distribution

Gov't should moderate natural spatial distribution of the population to avaliable land and resources

Subordination of womenPop. growth is a consequence of women's lack of economic opportunities

World resource depletion and environmental destruction Increasing population -> increasing use of resources --> increasing destruction of environment

Population Growth - A Real Problem The Extremist Argument: Population and Global Crisis

Unrestrained pop. growth is a threat to humankindPrinciple cause for poverty, malnutrition, environmental degradationReduction of world pop. (mainly in developing world) is needed

The Theoretical Argument: Population-Poverty Cycles and the Need for Family-Planning Programs

Population-Poverty Cycle Theory: explain how poverty and high population growth become reinforcing Pop. growth exacerbates economic, social problems of underdevelopmentEquation (from Solow) --> y= f (K, L, R, T)

K = capital, L =labor, R = resources, and T = technology Holding resources fixed -> y- l = a(k-l) + t

y= rate of GNI growth, lowercases = rate of ___ growth , a = capital elasticity of output (constant) Assuming CRS, per capita income growth directly related to growth of capital-labor ratio (k-l) and residual effects of technology More capital --> more investment + savings to maintain growth in per capita income

Development = incentive for lower family size, needs technological means of achieving this

Negative consequences of population growthEconomic growth

Lowers Per Capita Income growth in most LDCsPoverty and Inequality

Negative consequences of population growth falls most heavily on the poorTherefore, poverty rises and inequality is exacerbated

Education Large family size and low income often limits education access to children

Health High fertility harms