Development EconomicsVII

Prof. Dr. Hans H. Bass

Jacobs University, Spring 2010

March 18, 2010 2

Development Economics Agenda March 18

III. Production and Sector Issues

1. Saving and Investment*1.1 Saving1.1.1 Taxonomy1.1.2 Stylized facts of saving in a cross-country comparison1.1.3 Theoretical approaches to explain saving behavior1.2 Investment

2. Primary Production: Agriculture (and Minerals)*) Source: Perkins/ Radelet / Lindauer 2006, pp. 365-428

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1.1 Saving Taxonomy

Sacrifice consumption from current income to provide resources necessary for investment for future gain

= SAVING:1. Domestic saving

(averages.: 20 % of GDP in LICs, 27 % in LMICs, 20 % in UMICs + HICs)1.1 Private domestic saving (from individuals / households):

formal savings institutions or by purchasing investment goods (jewelry, livestock, building materials ...)

1.2 From corporations (<3 % of GDP in HICs, very small in LICs/MICs)1.3 From government (<2% of GDP in LICs – 10 % in HICs)2. Foreign saving (< 2 % of GDP in LICs/MICs)2.1 Official development assistance (ODA)2.2 Private (external commercial borrowing and equity finance)

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1.1 Saving Taxonomy

1. Domestic saving1.1 Private domestic saving

(until recently neglected in development policy)1.2 From corporations1.3 From government

(until recently focused in development policy)Government revenues from taxes and tariffs = Government consumption (all current expenditures such as salaries, subsidies, maintenance costs, interest payments plus outlays for military hardware) + Government saving (to finance public investment)

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1.1 SavingStylized facts

of household saving

1. Within a particular country, higher-income households tend to save larger fractions of their income than lower-income households;

2. Within a particular country, household saving ratios tend to be roughly constant, more so in HICs than in LICs;

3. Across countries, household saving ratios vary with no clear relationship to income.

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1.1 Saving Household saving

Reasons for household saving:1. to generate higher future income by saving and investing2. to protect themselves from the risk of unexpected falls in

income in the future (drought, livestock diseases ...)

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1.1 SavingExplanations

of household saving

1. Absolute-income hypothesis (Keynes)2. Relative-income hypothesis (Duesenberry)3. Permanent-income hypothesis (Friedman)4. Life-cycle hypothesis (Modigliani)

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1.1 SavingAbsolute-income

hypothesis (Keynes)

Autonomous consumption Ca

constant marginal saving rate s S = – Ca + s Yd

Increasing disposal income results in an increasing average saving rate S/Yd

Only very weak empirical support (only for very short term)

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1.1 SavingRelative-income

hypothesis (Duesenberry)

Two time lines:1. Short term: consumers adjust their savings up or down with

little change in consumption2. Medium term: consumers adjust their consumption but

maintain a basic share of previous high level of consumption regardless of their current level of income (“ratchet effect”).In DCs a “demonstration effect” (Nurkse) operates to cause consumption to ratchet upward as incomes grow

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1.1 SavingPermanent-income

hypothesis (Friedman)

Two components of income:1. permanent income (i.e. stable over time)2. transitory income (i.e. non-recurring income)

S = - Ca + sp Yp+ st Yt

extreme version: sp = 0, st = 1 no empirical support

less extreme version: 0 < sp < st < 1 some empirical support

in DCs: Saving is a method of smoothing consumption in the face of volatile income! (Saving reason # 2)

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1.1 SavingLife-cycle hypothesis

(Modigliani)

Household income-expenditure life-cycle:young age: low income, high expenditures de-saving or low saving ratiomiddle age: high income, decreasing expenditures high savingold age: lower income, rising expenditures de-saving

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1.1 SavingLife-cycle hypothesis

(Modigliani)

Demographic life cycle:LICs: pre-transition stage = high young-age dependency per worker low saving ratesMICs: demographic transition stage = low young-age dependency per worker higher saving ratesHICs: post-transition stage = high old-age dependency per worker low saving rates

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1.1 Saving Other determinants

Population distribution:rural households have a higher savings ratio than urban households (precautionary saving: farmers’ incomes more variable than those of urban wage earners)

(lack of) access to formal credit and insurance markets:over-saving on the household level, such as necessity to accumulate a large share of saving in advance of opening a business or purchasing a house

culture-specific attitudes to thrift and consumption

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Development Economics Agenda March 18

III. Production and Sector Issues

1. Saving and Investment*1.1 Saving1.2 Investment1.2.1 Public Investment1.2.2 Private Investment

2. Primary Production: Agriculture (and Minerals)*) Source: Perkins/ Radelet / Lindauer 2006, pp. 365-428

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1.2 InvestmentPublic and private

investment

1. Public investment- if too large for individual private investors- if positive externalities (public goods: no exclusion from consumption possible and marginal costs near zero (non-rivalry); example lighthouse)- if generation of economic resources > costs- if greater return than all of the other available options- financed by taxes, fees, or new (PPP) finance methods

2. Private investment

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1.2 InvestmentPublic and private

investment

2. Private investmentespecially catching-up processes need both high levels of private investment and more-productive investment

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1.2 InvestmentPublic and private

investment

Governments can encourage private investment by: reducing risks of high rates of inflation, volatile exchange

rates, recurring financial crises ... (“macroeconomic stability”) providing reliable transport and communication

infrastructure making imported inputs readily available (opening up the

economy) (danger: import competition!) providing internal security lowering institutional costs of doing business

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1.2 Investment Costs to start a business

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1.2 InvestmentReducing

costs of doing business

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1.2 Investment „The Mystery of Capital“

H. de Soto: the poor in DCs have substantial assets that they are unable to use to leverage investment because of weak institutions and inadequate rules and procedures(example: no land titles no collateral)

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Development Economics Agenda March 18

III. Production and Sector Issues

1. Saving and Investment2. Primary Production: Agriculture (and Minerals)

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(1) Increases in labor productivity in agriculture (agricultural revolution often preceding an industrial revolution)

(2) Transformation from subsistence production to market production increases urban domestic consumption or exports (lower urban wages, more forex)

(3) Rural laborers becoming redundant, farmers accumulate capital both transferred to industry (“factor effect”)

(4) Rural population absorbs industrial products (“market effect”)

2. Primary Production

The historical experience of agricultural transformation in

Europe: Stylized facts

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2. Primary Production

Declining share of agriculture in labor force and GDP in today‘s

DCs, but exceptions

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2. Primary Production Cereal Yields 1960-2005

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Early development economists (e.g. Lewis): agricultural innovations retarding capital accumulation in the modern sector by rising the supply price of labor – agriculture as the “handmaiden of an industrial push” at best: passive, supporting role

technology pessimism: science-based, input-intensive agriculture (HYV) scale-neutral; allegedly slow dissemination of innovations

2. Primary Production

Reasons for the neglect of agriculture in early

development strategies

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domestic demand pessimism: low income elasticity of demand for food (Engel’s Law) in addition to low price elasticity of demand

trade pessimism (Prebish-Singer Hypothesis) linkage pessimism: agriculture an unlikely growth pole institutional pessimism: too powerful landowners

2. Primary Production

Reasons for the neglect of agriculture in early

development strategies

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a shrinking agricultural sector supplying a growing industrial sector needs innovations in agriculture!

scale-neutrality of agricultural innovations is a strength egalitarian growth!

income elasticity of demand for grain rises (low income levels: more varieties, middle income levels: meat)

linkage pessimism factually unjustified (Irma Adelman) institutional reforms needed towards owner-operated,

medium size farming

2. Primary Production Towards a new sector strategy

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accelerated output growth through technological, institutional, and price incentive changes designed to raise the productivity of family farms

rising domestic demand for agricultural output derived from an employment-oriented urban development strategy

diversified, non-agricultural, labor-intensive rural development activities

2. Primary Production ”Integrated rural

development” or...

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Improve productivity of food-agriculture on small/medium farms,

invest in agricultural infrastructure, disseminate appropriate technology, and generate induced demand for industrial output through

increased demand for industrial inputs and consumption of manufactures by farmers

2. Primary Production ... Agricultural-demand led

industrialization strategy (ADLI)